**UNITED
      STATES SECURITIES AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**










**Form
      10-QSB**







x
            QUARTERLY
                REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF
                1934




For
      the
      period ended September 30,
      2007




o
            TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
                ACT OF 1934




For
      the
      transition period from ________ to ________




Commission
      file number   000-51006





**HARBIN
      ELECTRIC, INC.**


(Exact
      name of small business issuer in its charter)




**Nevada**
            **98-0403396**(State
                or other jurisdiction of
              incorporation
                or organization)
            (I.R.S.
                Employer
              Identification
                Number)







**No.
      9 Ha Ping Xi Lu, Ha Ping Lu Ji Zhong Qu**


**Harbin
      Kai Fa Qu, Harbin, People’s Republic of China 150060**


(Address
      and telephone number of principal executive offices)




**Telephone:
      215-854-8104**


(Issuer’s
      telephone number)







Check
      whether the issuer (1) filed all reports required to be filed by Section 13
      or 15(d) of the Securities Exchange Act of 1934, during the past 12 months
      (or for such shorter period that the registrant was required to file such
      reports), and (2) has been subject to such filing requirements for the past
      90
      days. Yes xNoo




Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act). Yes o No x




**APPLICABLE
      ONLY TO ISSUERS INVOLVED IN BANKRUPTCY**


**PROCEEDINGS
      DURING THE PRECEDING FIVE YEARS**




Check
      whether the registrant filed all documents and reports required to be filed
      by
      Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 after
      the distribution of securities under a plan confirmed by a court.
      Yes xNoo




**APPLICABLE
      ONLY TO CORPORATE ISSUERS**




State
      the
      number of shares outstanding of each of the issuer’s classes of common equity,
      as of September 30, 2007: 17,667,995 shares of common stock, par value $0.00001
      per share.




Transitional
      Small Business Disclosure Format (Check one): Yes o No x













**TABLE
      OF CONTENTS**




**Page****Part
                I. Financial Information**Item
                1. Financial Statements
            1Consolidated
                Balance Sheets (Unaudited)
              As
                of September 30, 2007 and December 31, 2006
            1Consolidated
                Statements of Income and Other Comprehensive Income
                (Unaudited)
              For
                the Nine Months and Three Months Ended September 30, 2007 and
                2006
            2Consolidated
                Statements of Stockholders’ Equity (Unaudited)
            3Consolidated
                Statements of Cash Flows (Unaudited)
              For
                  the Nine Months Ended September 30, 2007 and 2006
            4Notes
                to the Consolidated Financial Statements (Unaudited)
            5Item
                1A. Risk Factors
            30Item
                2. Management’s Discussion and Analysis or Plan of
                Operation
            36Item
                3. Controls and Procedures
            43**Part
                II. Other Information**Item
                1. Legal Proceedings.
            44Item
                2. Unregistered Sales of Equity Securities and Use of
                Proceeds.
            44Item
                3. Defaults upon Senior Securities.
            44Item
                4. Submission of Matters to a Vote of Securities Holders.
            44Item
                5. Other Information.
            44Item
                6. Exhibits.
            45Signatures
            49Index
                to Exhibits
            49







**PART
      I. FINANCIAL INFORMATION**




**Item
      1. Financial Statements (Unaudited)**





HARBIN
      ELECTRIC, INC. AND SUBSIDIARIES





CONSOLIDATED
      BALANCE SHEETS


AS
      OF
      SEPTEMBER 30, 2007 AND DECEMBER 31, 2006





SEPTEMBER 30,
              2007
            
            DECEMBER 31,
              2006UNAUDITEDA
                S S E T SCURRENT
                ASSETS:Cash
            
            $
            61,060,638
            
            $
            67,313,919Accounts
                receivable, net of allowance for doubtful accounts of $46,359 and
                $44,552
                as of September 30, 2007 and December 31, 2006,
                respectively
            
            
            12,521,547
            
            
            8,827,799Inventories
            
            
            1,876,962
            
            
            583,287Other
                receivables
            
            
            452,897
            
            
            148,243Other
                receivables - related parties
            
            
            5,069
            
            
            44,998Advances
                on inventory purchases
            
            
            1,781,398
            
            
            834,590Total
                current assets
            
            
            77,698,511
            
            
            77,752,836PLANT
                AND EQUIPMENT, net
            
            
            18,499,903
            
            
            9,219,534OTHER
                ASSETS:Debt
                issue costs, net of amortization
            
            
            2,183,661
            
            
            2,757,155Advances
                on equipment purchases
            
            
            12,922,994
            
            
            -Advances
                on intangible assets
            
            
            1,347,340
            
            
            1,487,120Intangible
                assets, net of accumulated amortization
            
            
            6,117,619
            
            
            640,337Other
                assets
            
            
            508,008
            
            
            1,101,839Deposit
                in derivative hedge
            
            
            1,017,524
            
            
            -Total
                other assets
            
            
            24,097,146
            
            
            5,986,451Total
                assets
            
            $
            120,295,560
            
            $
            92,958,821L
                I A B I L I T I E S  A N D  S H A R E H O L D E R S'  E Q U
                I T YCURRENT
                LIABILITIES:Accounts
                payable
            
            $
            520,461
            
            $
            258,911Other
                payables
            
            
            379,936
            
            
            406,520Other
                payables - related party
            
            
            33,641
            
            
            -Accrued
                liabilities
            
            
            165,168
            
            
            107,263Customer
                deposits
            
            
            724,395
            
            
            319,261Taxes
                payable
            
            
            779,987
            
            
            556,943Interest
                payable
            
            
            -
            
            
            1,122,000Total
                current liabilities
            
            
            2,603,588
            
            
            2,770,898NOTES
                PAYABLE, net of debt discount $18,011,302 and $21,410,401 as of September
                30, 2007 and December 31, 2006, respectively
            
            
            31,988,698
            
            
            28,589,599FAIR
                VALUE OF DERIVATIVE INSTRUMENT
            
            
            7,047,406
            
            
            -WARRANT
                LIABILITIES
            
            
            -
            
            
            16,568,080Total
                liabilities
            
            
            41,639,692
            
            
            47,928,577COMMITMENTS
                AND CONTINGENCIES
            
            
            -
            
            
            -SHAREHOLDERS'
                EQUITY:Common
                Stock, $0.00001 par value, 100,000,000 shares authorized, 17,667,995
                and
                16,600,451 shares issued and outstanding as of September 30, 2007
                and
                December 31, 2006, respectively
            
            
            177
            
            
            166Paid-in-capital
            
            
            42,597,639
            
            
            12,252,064Retained
                earnings
            
            
            32,593,816
            
            
            26,222,408Statutory
                reserves
            
            
            4,523,715
            
            
            4,523,715Accumulated
                other comprehensive (loss) income
            
            
            (1,059,479
            )
            
            2,031,891Total
                shareholders' equity
            
            
            78,655,868
            
            
            45,030,244Total
                liabilities and shareholders' equity
            
            $
            120,295,560
            
            $
            92,958,821




The
        accompanying notes are an integral part of these consolidated
        statements.


-
          1 -





HARBIN
      ELECTRIC, INC. AND SUBSIDIARIES





CONSOLIDATED
      STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME





(UNAUDITED)





FOR THE THREE MONTHS
              ENDED SEPTEMBER 30,
            
            FOR THE NINE MONTHS
              ENDED SEPTEMBER 30,2007
            
            2006
            
            2007
            
            2006REVENUES
            
            $
            18,500,038
            
            $
            9,817,053
            
            $
            46,115,945
            
            $
            28,407,056COST
                OF SALES
            
            
            9,438,347
            
            
            5,012,556
            
            
            22,975,956
            
            
            14,528,032GROSS
                PROFIT
            
            
            9,061,691
            
            
            4,804,497
            
            
            23,139,989
            
            
            13,879,024RESEARCH
                AND DEVELOPMENT EXPENSE
            
            
            298,524
            
            
            397,074
            
            
            751,883
            
            
            1,223,828SELLING,
                GENERAL AND ADMINISTRATIVE EXPENSES
            
            
            1,700,854
            
            
            1,634,766
            
            
            4,661,175
            
            
            3,065,619INCOME
                FROM OPERATIONS
            
            
            7,062,313
            
            
            2,772,657
            
            
            17,726,931
            
            
            9,589,577Other
                (income) expense, net
            
            
            (2,388
            )
            
            697,040
            
            
            (11,698
            )
            
            643,893Non-operating
                (income), net
            
            
            (11,074
            )
            
            -
            
            
            (774,482
            )
            
            -Realized
                (gain) on sale of marketable securities
            
            
            -
            
            
            -
            
            
            -
            
            
            (571,143
            )Interest
                expense (income), net
            
            
            2,236,255
            
            
            (26,569
            )
            
            5,713,372
            
            
            (57,602
            )Change
                in fair value of warrant
            
            
            -
            
            
            (2,180,970
            )
            
            -
            
            
            (2,180,970
            )OTHER
                EXPENSE (INCOME), NET
            
            
            2,222,793
            
            
            (1,510,499
            )
            
            4,927,192
            
            
            (2,165,822
            )INCOME
                BEFORE PROVISION FOR INCOME TAXES
            
            
            4,839,520
            
            
            4,283,156
            
            
            12,799,739
            
            
            11,755,399PROVISION
                FOR INCOME TAXES
            
            
            75,298
            
            
            -
            
            
            75,298
            
            
            -NET
                INCOME
            
            
            4,764,222
            
            
            4,283,156
            
            
            12,724,441
            
            
            11,755,399OTHER
                COMPREHENSIVE LOSSForeign
                currency translation adjustment
            
            
            1,638,750
            
            
            407,742
            
            
            3,956,036
            
            
            730,097Currency
                hedges adjustment Change in fair value of derivative
                instrument
            
            
            (3,945,951
            )
            
            -
            
            
            (7,047,406
            )
            
            -Adjustment
                for gain on sales of marketable securities
            
            
            -
            
            
            -
            
            
            -
            
            
            (587,171
            )COMPREHENSIVE
                INCOME
            
            $
            2,457,021
            
            $
            4,690,898
            
            $
            9,633,071
            
            $
            11,898,325BASICWeighted
                average number of shares
            
            
            17,226,880
            
            
            16,600,451
            
            
            16,810,065
            
            
            16,600,451Earning
                per share
            
            $
            0.28
            
            $
            0.26
            
            $
            0.76
            
            $
            0.71DILUTEDWeighted
                average number of shares
            
            
            18,632,246
            
            
            17,495,254
            
            
            18,215,411
            
            
            19,235,134Earning
                per share
            
            $
            0.26
            
            $
            0.24
            
            $
            0.70
            
            $
            0.61




The
        accompanying notes are an integral part of these consolidated
        statements.




-
          2 -





HARBIN
      ELECTRIC, INC. AND SUBSIDIARIES





CONSOLIDATED
      STATEMENTS OF SHAREHOLDERS' EQUITY





Common stock
            
            Additional
            
            Retained
                earnings
            
            Accumulated otherNumber
            
            Par
            
            paid-in
            
            Unrestricted
            
            Statutory
            
            comprehensiveof
                shares
            
            value
            
            capital
            
            retained earnings
            
            reserves
            
            income
            
            TotalsBALANCE,
                January 1, 2006
            
            
            16,600,451
            
            $
            166
            
            $
            11,297,676
            
            $
            10,460,887
            
            $
            1,846,724
            
            $
            997,466
            
            $
            24,602,919Stock
                based compensation
            
            
            
            
            
            
            
            
            742,299
            
            
            
            
            
            
            
            
            
            
            
            742,299Adjustment
                to statutory reserve
            
            
            
            
            
            
            
            
            
            
            
            (1,650,105
            )
            
            1,650,105
            
            
            
            
            
            -Net
                income
            
            
            
            
            
            
            
            
            
            
            
            11,755,397
            
            
            
            
            
            
            
            
            11,755,397Unrealized
                loss on investment
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (587,171
            )
            
            (587,171
            )Foreign
                currency translation gain
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            730,097
            
            
            730,097BALANCE,
                September 30, 2006, unaudited
            
            
            16,600,451
            
            $
            166
            
            $
            12,039,975
            
            $
            20,566,179
            
            $
            3,496,829
            
            $
            1,140,392
            
            $
            37,243,541Capital
                contribution
            
            
            
            
            
            
            
            
            36,300
            
            
            
            
            
            
            
            
            
            
            
            36,300Stock
                based compensation
            
            
            
            
            
            
            
            
            175,789
            
            
            
            
            
            
            
            
            
            
            
            175,789Adjustment
                to statutory reserve
            
            
            
            
            
            
            
            
            
            
            
            (1,026,886
            )
            
            1,026,886
            
            
            
            
            
            -Net
                income
            
            
            
            
            
            
            
            
            
            
            
            6,683,115
            
            
            
            
            
            
            
            
            6,683,115Realized
                loss on investment
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            587,171
            
            
            587,171Foreign
                currency translation gain
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            304,328
            
            
            304,328BALANCE,
                December 31, 2006
            
            
            16,600,451
            
            $
            166
            
            $
            12,252,064
            
            $
            26,222,408
            
            $
            4,523,715
            
            $
            2,031,891
            
            $
            45,030,244Reclassification
                of warrant liabilities to equity
            
            
            
            
            
            
            
            
            22,921,113
            
            
            (6,353,033
            )
            
            
            
            
            
            
            
            16,568,080Exercise
                of stock warrants at $3.50
            
            
            62,500
            
            
            1
            
            
            218,749
            
            
            
            
            
            
            
            
            
            
            
            218,750Stock
                based compensation
            
            
            
            
            
            
            
            
            705,723
            
            
            
            
            
            
            
            
            
            
            
            705,723Stock
                issued in acquisition
            
            
            473,354
            
            
            5
            
            
            6,499,995
            
            
            
            
            
            
            
            
            
            
            
            6,500,000Cashless
                exercised of warrants
            
            
            531,650
            
            
            5
            
            
            (5
            )
            
            
            
            
            
            
            
            
            
            
            -Net
                income
            
            
            
            
            
            
            
            
            
            
            
            12,724,441
            
            
            
            
            
            
            
            
            12,724,441Foreign
                currency translation gain
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            3,956,036
            
            
            3,956,036Net
                change related to cash flow hedges
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (7,047,406
            )
            
            (7,047,406
            )BALANCE,
                September 30, 2007, unaudited
            
            
            17,667,955
            
            $
            177
            
            $
            42,597,639
            
            $
            32,593,816
            
            $
            4,523,715
            
            $
            (1,059,479
            )
            $
            78,655,868




The
        accompanying notes are an integral part of these consolidated
        statements.




-
          3 -


HARBIN
      ELECTRIC, INC. AND SUBSIDIARIES





CONSOLIDATED
      STATEMENTS OF CASH FLOWS


FOR
      THE
      NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006


(UNAUDITED)





2007
            
            2006CASH
                FLOWS FROM OPERATING ACTIVITIES:Net
                income
            
            $
            12,724,441
            
            $
            11,755,399Adjustments
                to reconcile net income to cash provided by (used in) operating
                activities:Depreciation
            
            
            505,270
            
            
            180,438Amortization
                of intangible assets
            
            
            241,351
            
            
            34,402Amortization
                of debt issuance costs
            
            
            573,494
            
            
            -Amortization
                of debt discount
            
            
            3,399,099
            
            
            -Gain
                on derivative instrument
            
            
            (554,602
            )
            
            -Realized
                gain on sale of marketable securities
            
            
            -
            
            
            (571,143
            )Change
                in fair value of warrants
            
            
            -
            
            
            (2,180,970
            )Stock
                based compensation
            
            
            705,723
            
            
            701,918Change
                in operating assets and liabilitiesAccounts
                receivable
            
            
            (1,880,732
            )
            
            (3,540,547
            )Inventories
            
            
            (988,989
            )
            
            894,533Other
                receivables
            
            
            (282,972
            )
            
            -Other
                receivables - related parties
            
            
            40,889
            
            
            -Advances
                on inventory purchases
            
            
            (894,067
            )
            
            769,575Other
                assets
            
            
            819,773
            
            
            (3,134,032
            )Accounts
                payable
            
            
            311,989
            
            
            773,880Other
                payables
            
            
            (43,442
            )
            
            -Other
                payables - Related Party
            
            
            24,589
            
            
            -Accrued
                liabilities
            
            
            52,785
            
            
            -Customer
                deposits
            
            
            98,927
            
            
            429,661Taxes
                payable
            
            
            196,511
            
            
            -Net
                cash provided by operating activities
            
            
            15,050,037
            
            
            6,113,114CASH
                FLOWS FROM INVESTING ACTIVITIES:Advances
                on equipment purchases
            
            
            (12,536,210
            )
            
            -Additions
                to intangible assets
            
            
            (2,282,885
            )
            
            -Additions
                to plant and equipment
            
            
            (7,384,918
            )
            
            (534,113
            )Proceed
                from cross currency hedge
            
            
            554,602
            
            
            -Proceeds
                from sale of marketable securities
            
            
            -
            
            
            1,093,165Net
                cash (used in) provided by investing activities
            
            
            (21,649,411
            )
            
            559,052CASH
                FLOWS FINANCING ACTIVITIES:Proceeds
                received from conversion of warrants
            
            
            218,750
            
            
            -Deposit
                to secure derivative instrument
            
            
            (1,000,000
            )
            
            -Capital
                contribution
            
            
            -
            
            
            39,081Net
                proceeds from debt issued
            
            
            -
            
            
            47,462,700Interest
                payable
            
            
            (1,122,000
            )
            
            277,778Net
                cash (used in) provided by financing activities
            
            
            (1,903,250
            )
            
            47,779,559EFFECTS
                OF EXCHANGE RATE CHANGE IN CASH
            
            
            2,249,343
            
            
            403,025(DECREASE)
                INCREASE IN CASH
            
            
            (6,253,281
            )
            
            54,854,750CASH,
                beginning of period
            
            
            67,313,919
            
            
            5,739,019CASH,
                end of period
            
            $
            61,060,638
            
            $
            60,593,769SUPPLEMENTAL
                DISCLOSURE OF CASH FLOW INFORMATION:Cash
                paid for interest expense
            
            $
            4,578,780
            
            $
            -Cash
                paid for income taxes
            
            $
            14,009
            
            $
            -




The
        accompanying notes are an integral part of these consolidated
        statements.




-
          4 -


HARBIN
      ELECTRIC, INC. AND SUBSIDIARIES





NOTES
      TO
      THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
      30, 2007


(UNAUDITED)





**Note
      1 – Organization and description of business**





Harbin
      Electric, Inc, (the “Company”) is a Nevada corporation, incorporated on July 9,
      2003 under the name Torch Executive Services Ltd. The Company through its
      indirect wholly-owned subsidiary, Harbin Tech Full Electric Co., Ltd. (“HTFE”),
      develops, engineers, manufactures and sells a wide array of customized linear
      motors and other special motors.





On
      April
      9, 2007, the Company entered into an Agreement with Shelton Technology, LLC
      (“Shelton”), Shaotang Chen (“Dr Chen”) and Xiaogang Luo (“Dr Luo”) whereby the
      Company and Shelton agreed to work together through the Company’s newly formed,
      wholly-owned subsidiary, Advanced Automation Group, LLC (“AAG”) to design,
      develop and manufacture custom industrial automation controllers. The Company
      is
      required to contribute $3,000,000 to AAG in 3 installments: $1.2 million was
      paid on April 16, 2007, $800,000 by May 1, 2008 and $1,000,000 by March 31,
      2009. Shelton contributed an exclusive worldwide royalty-free license for
      motorized automation technology. Shelton is entitled to receive 49% of any
      profits earned by AAG through the initial term of the Agreement. The initial
      term begins April 9, 2007 and terminates August 31, 2008.





On
      June
      16, 2007, the Company and HTFE entered into an asset purchase agreement with
      Harbin Taifu Auto Electric Co., Ltd., a company that was owned 98% by the
      Company’s Chairman and Chief Executive Officer and 2% by other Company
      management. The aggregate purchase totaled $10,500,000 consisting of $4,000,000
      in cash and $6,500,000 is newly issued Company common stock or 473,354
      shares, based on the average price for the immediately preceeding fifteen
      consecutive trading days of $13.73. All assets will be used to produce electric
      motors with technical support and certified patents. An appraisal report dated
      July 16, 2007 assessed the fair market value of the acquired assets at RMB
      79,550,756, approximately $10.5 million. The Company recorded the asset
      acquisition at fair value, none of the purchase price was allocated to goodwill.





In
      December 2006, the Company formed Shanghai Tech Full Electric (Shanghai Tech
      Full) a wholly-owned subsidiary, to develop and manufacture electric motor
      accessories. The Company invested approximately $4,780,000 in construction
      on
      plant as of September 30, 2007. Shanghai Tech Full is expected to begin
      production in 2008.





**Note
      2 – Accounting policies**





Use
      of
      estimates





The
      preparation of financial statements in conformity with generally accepted
      accounting principles requires management to make estimates and assumptions
      that
      affect the reported amounts of assets and liabilities and disclosure of
      contingent assets and liabilities at the date of the financial statements and
      the reported amounts of revenues and expenses during the reporting period.
      For
      example, the Company estimated the fair value of warrants using subjective
      assumptions including estimated length of time employees will retain their
      options before exercising them, forfeitures, and expected volatility of
      Company’s stock price over the expected term. Changes in these assumptions can
      materially affect the estimated fair value and the resulting expense. Actual
      results could differ from management’s estimates.




-
          5 -


HARBIN
        ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2007
 (UNAUDITED)
  Basis
      of presentation





The
      consolidated financial statements of Harbin Electric Inc. reflect the activities
      of the following subsidiaries:


Percentage ofOwnershipAdvanced
                  Electric Motors, Inc
              
              Delaware, USA
              
              
              100
              %Harbin
                  Tech Full Electric, Co., Ltd
              
              Harbin, China
              
              
              100
              %Advanced
                  Automation Group, LLC
              
              Delaware, USA
              
              
              100
              %Shanghai
                  Tech Er Full Electric
              
              Shanghai, China
              
              
              100
              %


T he
        accompanying financial statements have been prepared in accordance with
        accounting principles generally accepted in the United States of America.
        All
        material intercompany transactions and balances have been eliminated in the
        consolidation.





Concentration
      of risks





The
      Company considers all highly liquid investments with original maturities of
      three months or less at the time of purchase to be cash equivalents, for cash
      flow statement purposes. Cash includes cash on hand and demand deposits in
      accounts maintained with state owned banks within the People’s Republic of China
      (“PRC”) and the United States. Certain f inancial
      instruments, which subject the Company to concentration of credit risk, consist
      of cash. The Company maintains balances at financial institutions which, from
      time to time, may exceed Federal Deposit Insurance Corporation insured limits
      for the banks located in the Unites States. Balances at financial institutions
      or state owned banks within the PRC are not covered by insurance. As of September
      30, 2007 and
      December 31, 2006, the Company had deposits in excess of federally insured
      limits totaling $60,960,638 and $67,221,852, respectively. The Company has
      not
      experienced any losses in such accounts and believes it is not exposed to any
      significant risks on its cash in bank accounts.





Five
      major customers accounted for approximately 77% of the net revenue for the
      period ended September
      30, 2007 ,
      with
      each customer individually accounting for 22%, 22%, 16%, 9%, and 8%,
      respectively.  At September
      30, 2007 ,
      the
      total receivable balance due from these customers was $12,521,547 .
      Four
      major customers accounted for 82% of the net revenue for the nine months period
      ended September
      30, 2006 .
      At September
      30, 2006 ,
      the
      total receivable balance due from these customers was $9,266,100.




-
          6 -


HARBIN
        ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2007
 (UNAUDITED)
  Five
      major vendors provided approximately 82% of the Company’s purchases of raw
      materials for the period ended September
      30, 2007 ,
      with
      each vendor individually accounting for 29%, 21%, 14%, 12% and 6%, respectively.
      The Company’s accounts payable to these vendors was $0 at September
      30, 2007 .
      Four
      vendors provided 87% of the Company’s purchase of raw materials for the nine
      month period ended September
      30, 2006 .
      The
      Company’s accounts payable to these vendors was $0 at September
      30, 2006 .





The
      Company’s operations are carried out in the PRC. Accordingly, the Company’s
      business, financial condition and results of operations may be influenced by
      the
      political, economic and legal environments in the PRC, and by the general state
      of the PRC’s economy. The Company’s operations in the PRC are subject to
      specific considerations and significant risks not typically associated with
      companies in the North America and Western Europe. These include risks
      associated with, among others, the political, economic and legal environments
      and foreign currency exchange. The Company’s results may be adversely affected
      by changes in governmental policies with respect to laws and regulations,
      anti-inflationary measures, currency conversion and remittance abroad, and
      rates
      and methods of taxation, among other things.





Accounts
      receivable





The
      Company’s policy is to maintain reserves for potential credit losses on accounts
      receivable. Management reviews the composition of accounts receivable and
      analyzes historical bad debts, customer concentrations, customer credit
      worthiness, current economic trends and changes in customer payment patterns
      to
      evaluate the adequacy of these reserves. The Company had accounts receivable,
      net of allowance for doubtful accounts of $12,521,547 and $8,827,799 as of September
      30, 2007 and
      December 31, 2006, respectively. The allowance for doubtful accounts amounted
      to $46,359 and $44,552 as of September
      30, 2007 and
      December 31, 2006, respectively.





Investment
      in marketable securities





Securities
      available for sale are carried at fair value with unrealized gains and losses
      reported as accumulated other comprehensive income in the stockholders’ equity
      section of the balance sheet. Realized gains and losses on securities available
      for sale are included in other income (expense) and, when applicable, are
      reported as a reclassification adjustment in other comprehensive income. Gains
      and losses on the sale of available for sale securities are determined using
      the
      specific-identification method.




-
          7 -


HARBIN
        ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2007
 (UNAUDITED)


The
      realized gain was $571,143 for the nine months ended September 30, 2006. The
      Company determines cost on specific identification method. All marketable
      securities were sold during 2006 and the related unrealized gains totaling
      $587,171 were released from other comprehensive income. The Company no longer
      holds marketable securities.





Inventories





Inventory
      is composed of raw material for manufacturing electrical motors, work in
      process, and finished goods. Inventory is valued at the lower of cost or market
      value using weighted average method. Management compares the cost of inventory
      with the market value and an allowance is made for writing down the inventory
      to
      its market value, if lower than cost.





Plant
      and equipment





Plant
      and
      equipment are stated at cost. Expenditures for maintenance and repairs are
      charged to earnings as incurred; additions, renewals and betterments are
      capitalized. When assets are retired or otherwise disposed of, the related
      cost
      and accumulated depreciation are removed from the respective accounts, and
      any
      gain or loss is included in operations. Depreciation of plant and equipment
      is
      provided using the straight-line method for substantially all assets with
      estimated lives as follows:




EstimatedUseful LifeBuildings
              
              
              20
                  yearsVehicle
              
              
              5
                  yearsOffice
                  equipment
              
              
              5
                  yearsProduction
                  equipment
              
              
              10
                  years




Construction
      in progress represents the costs incurred in connection with the construction
      of
      buildings or new additions to the Company’s plant facilities. No depreciation is
      provided for construction in progress until such time as the assets are
      completed and placed into service.





The
      Company periodically evaluates the carrying value of long-lived assets in
      accordance with SFAS 144. When estimated cash flows generated by those assets
      are less than the carrying amounts of the asset, the Company recognizes an
      impairment loss. Based on its review, the Company believes that, as of September
      30, 2007 ,
      there
      were no impairments of its long-lived assets.





Stock-based
      compensation





The
      Company records stock based compensation expense pursuant to SFAS No 123R.
      The
      Company estimates the fair value of the award using the Black-Scholes Option
      Pricing Model. Under SFAS No. 123R, the Company’s expected volatility assumption
      is based on the historical volatility of Company’s stock. The expected life
      assumption is primarily based on historical exercise patterns and employee
      post-vesting termination behavior. The risk-free interest rate for the expected
      term of the option is based on the U.S. Treasury yield curve in effect at the
      time of grant.




-
          8 -


HARBIN
        ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2007
 (UNAUDITED)
  Stock
      compensation expense is recognized based on awards expected to vest, and there
      were no estimated forfeitures as the Company has a short history of issuing
      options. SFAS No. 123R requires forfeitures to be estimated at the time of
      grant and revised in subsequent periods, if necessary, if actual forfeitures
      differ from those estimates.





Revenue
      recognition





The
      Company’s revenue recognition policies are in compliance with Staff Accounting
      Bulletin (“SAB”) 104. Sales revenue is recognized at the date of shipment to
      customers when a formal arrangement exists, the price is fixed or determinable,
      the delivery is completed, no other significant obligations of the Company
      exist
      and collectability is reasonably assured. Payments received before all of the
      relevant criteria for revenue recognition are recorded as customer deposits.





In
      addition, revenue recognition could be negatively impacted by returns. However,
      the Company makes custom products which are customer specific, and no returns
      are allowed. The Company warrants the product for repair only in the event
      of
      defects for two years from the date of shipment. Historically, the Company
      has
      not experienced significant defects, and replacements for defects have not
      been
      material. The Company charges such costs to cost of goods sold. For the nine
      months ended September
      30, 2007 and 2006 such
      returns and allowances were $0. Should returns increase in the future it would
      be necessary to adjust the estimates, in which case recognition of revenues
      could be delayed.





Shipping
      and handling costs related to costs of goods sold are included in selling,
      general and administrative costs and totaled $402,990 and
      $184,232 for the nine months ended September
      30, 2007 and 2006 and
      totaled $178,243 and $54,372 for the three months ended September
      30, 2007 and 2006 .





Income
      taxes





The
      Company utilizes Statement of Financial Accounting Standards (SFAS) No. 109,
      "Accounting for Income Taxes," which requires the recognition of deferred tax
      assets and liabilities for the expected future tax consequences of events that
      have been included in the financial statements or tax returns. The
      Company adopted FASB Interpretation 48, “Accounting for Uncertainty in Income
      Taxes” (“FIN 48”), as of January 1, 2007. A tax position is recognized as a
      benefit only if it is “more likely than not” that the tax position would be
      sustained in a tax examination, with a tax examination being presumed to occur.
      The amount recognized is the largest amount of tax benefit that is greater
      than
      50% likely of being realized on examination. For tax positions not meeting
      the
“more likely than not” test, no tax benefit is recorded. The adoption had no
      affect on the Company’s financial statements.




-
          9 -


HARBIN
        ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2007
 (UNAUDITED)
  Under
      this method, deferred income taxes are recognized for the tax consequences
      in
      future years of differences between the tax bases of assets and liabilities
      and
      their financial reporting amounts at each period end based on enacted tax laws
      and statutory tax rates applicable to the periods in which the differences
      are
      expected to affect taxable income. Valuation allowances are established, when
      necessary, to reduce deferred tax assets to the amount expected to be realized.
      There are no deferred tax amounts at September
      30, 2007 and December
      31, 2006 ,
      respectively.





The
      charge for taxation is based on the results for the quarter as adjusted for
      items, which are non-assessable or disallowed. It is calculated using tax rates
      that have been enacted or substantively enacted by the balance sheet
      date.





Under
      the
      Income Tax Laws of PRC, the Company is generally subject to income tax at an
      effective rate of 33% (30% state income taxes plus 3% local income taxes) on
      income reported in the statutory financial statements after appropriated tax
      adjustments, since the enterprise is located in a specially designated region
      where **** the
      Income Tax Laws of PRC allows foreign enterprises 50% income tax reduction
      and a
      two-year income tax exemption and an additional 50% income tax reduction for
      the
      following three years.




According
      to the Provisional Regulations of the People's Republic of China on Income
      Tax,
      the Document of Reductions and Exemptions of Income Tax for the Company has
      been
      approved by the local tax bureau and the Management Regulation of Harbin
      Economic and Technological Development Zone for the reporting period. The
      Company is exempt from income tax from July 1, 2004 through December 31, 2007.
      The Company has been approved to have its tax rate reduced by 50% from January
      1, 2008 to December 31, 2010.





Beginning
      January 1, 2008, the new Chinese Enterprise Income Tax (“EIT”) law will replace
      the existing laws for Domestic Enterprises (“DES”) and Foreign Invested
      Enterprises (“FIEs”). The new standard EIT rate of 25% will replace the 33% rate
      currently applicable to both DES and FIEs.





The
      following table reconciles the U.S. statutory rates to the Company’s effective
      tax rate for the nine months ended September
      30, 2007 and 2006 :




-
          10 -


HARBIN
        ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2007
 (UNAUDITED)
  SEPTEMBER
                  30,2007
              
              2006U.S.
                  Statutory rates
              
              
              34
              %
              
              34
              %Foreign
                  income not recognized in USA
              
              
              (34
              )
              
              (34
              )China
                  income taxes
              
              
              33
              
              
              33Tax
                  exemption
              
              
              (33
              )
              
              (33
              )Total
                  provision for income taxes
              
              
              -
              %
              
              -
              %




The
      estimated tax savings for the nine months ended September
      30, 2007 and 2006 amounted
      to $7,367,542 and $3,740,511. The net effect on earnings per share had the
      income tax been applied would decrease earnings per share from $ 0.76 to $
      0.32
      in 2007 and $
      0.73 to $ 0.48 in 2006 .





Harbin
      Electric, Inc. and Advanced Electric Motors, Inc. were incorporated in the
      United States and have incurred net operating losses for income tax purposes
      for
      the nine months ended September
      30, 2007 .
      The net
      operating loss carry forwards for United States income taxes amounted to
      $8,351,255 which may be available to reduce future years’ taxable income. These
      carry forwards will expire, if not utilize, through 2027 and 2024. Management
      believes that the realization of the benefits from these losses appears
      uncertain due to the Company’s limited operating history and continuing losses
      for United States income tax purposes. Accordingly, the Company has provided
      a
      100% valuation allowance on the deferred tax asset benefit to reduce the asset
      to zero. The net change in the valuation allowance for the nine month period
      ended September
      30, 2007 was an
      increase of $2,840,000. Management will review this valuation allowance
      periodically and make adjustments as warranted.





Value
      added tax





Sales
      revenue represents the invoiced value of goods, net of a value-added tax
      (“VAT”). All of the Company’s products that are sold in the PRC are subject to a
      Chinese value-added tax at a rate of 17% of the gross sales price. This VAT
      may
      be offset by VAT paid by the Company on raw materials and other materials
      included in the cost of producing their finished product. The Company recorded
      VAT Payable and VAT receivable net of payments in the financial statements.
      The
      VAT tax return is filed offsetting the payables against the
      receivables.





VAT
      on
      sales and VAT on purchases amounted to $7,828,751 and $3,776,913 for the nine
      months ended September
      30, 2007 and
      $4,381,379 and $2,283,576  for
      the
      nine months ended September
      30, 2006 ,
      respectively. Sales and purchases are recorded net of VAT collected and paid
      as
      the Company acts as an agent for the government. VAT taxes are not impacted
      by
      the income tax holiday.





Taxes
      payable consisted of the followings:




-
          11 -


HARBIN
        ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2007
 (UNAUDITED)


September 30, 2007
            
            December 31, 2006VAT
                tax payable
            
            $
            743,510
            
            $
            522,197Individual
                income tax payable
            
            
            1,927
            
            
            335Business
                tax payable
            
            
            -
            
            
            6,538Others
                misc. tax payable
            
            
            34,550
            
            
            27,873Total
            
            $
            779,987
            
            $
            556,943





Advertising
      costs





The
      Company expenses the cost of advertising as incurred in selling, general and
      administrative costs. Advertising costs were $ 1,070 and
      $323,820 for the nine months ended September
      30, 2007 and 2006 ,
      respectively, and $1,070 and
      $63,845 for the three months ended September
      30, 2007 and 2006 ,
      respectively.





Research
      and development costs





Research
      and development costs are expensed as incurred. The costs of material and
      equipment that are acquired or constructed for research and development
      activities, and have alternative future uses; either in research and
      development, marketing, or sales are classified as plant and equipment and
      depreciated over their estimated useful lives.





Fair
      value of financial instruments





Statement
      of financial accounting standard No. 107, “Disclosures about Fair Value of
      Financial Instruments,” requires that the Company disclose estimated fair values
      of financial instruments. The carrying amounts reported in the balance sheets
      for current assets and current liabilities qualifying as financial instruments
      are a reasonable estimate of fair value. The Company considers the carrying
      amount of cash, accounts receivable, other receivables, accounts payable,
      accrued liabilities and other payables to approximate their fair values because
      of the short period of time between the origination of such instruments and
      their expected realization and their current market rate of interest.





Derivative
      instrument





The
      Company uses a cross currency hedge, a derivative financial instrument, to
      hedge
      the risk of rising interest rates on their variable interest rate debt. This
      type of derivative financial instrument is known as a cash flow hedge. The
      Company accounts for this interest rate swap in accordance with FAS No. 133,
      “Accounting for Derivatives Instruments and Hedging Activity,” which requires
      the derivative to be carried on the balance sheet at fair value and to meet
      certain documentary and analytical requirements to qualify for hedge accounting
      treatment. The above derivative qualifies for hedge accounting under FAS 133
      and, accordingly, changes in the fair value is reported in accumulated other
      comprehensive income, net of related income tax effects. Amounts included in
      accumulated other comprehensive income are reclassified into earnings when
      the
      hedged transaction effects earnings.




-
          12 -


HARBIN
        ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2007
 (UNAUDITED)
  At
      the
      inception of the transaction, the Company documents the relationship between
      hedging instruments and hedged items, as well as its risk management objective
      and the strategy for undertaking various hedge transactions. This process
      includes linking all derivatives designated to specific firm commitments of
      forecast transactions. The Company also documents its assessment, both at
      inception and on an ongoing basis, of whether the derivative financial
      instruments that are used in hedging transactions are highly effective in
      offsetting changes in fair values or cash flows of hedged items. Any portion
      deemed ineffective is recorded in earnings with the effective portion reflected
      in accumulated other comprehensive. Changes in the fair values of derivative
      instruments accounted for as cash flow hedges, to the extent they qualify for
      hedge accounting, are recorded in accumulated other comprehensive income. On
      April 2, 2007, $5,387,485 was recorded as a loss on the derivative investment
      in
      other comprehensive income (loss) upon entering into the hedge agreement. As
      of September
      30, 2007 ,
      the
      change in the fair value of the derivative instrument totaled $1,659,921 and
      was
      recorded in other comprehensive loss.





Foreign
      currency transactions





The
      reporting currency of the Company is the US dollar. The functional currency
      of
      HTFE is the Chinese Renminbi. The financial statements of HTFE are translated
      to
      United States dollars using quarter-end exchange rates as to assets and
      liabilities and average exchange rates as to revenues and expenses and cash
      flows. Capital accounts are translated at their historical exchange rates when
      the capital transaction occurred. Translation adjustments resulting from this
      process are included in accumulated other comprehensive income in the statement
      of shareholders’ equity. Transaction gains and losses that arise from exchange
      rate fluctuations on transactions denominated in a currency other than the
      functional currency are included in the results of operations as
      incurred.





Translation
      adjustments resulting from this process amounted to $(1,059,479) and $2,031,891
      as of September
      30, 2007 and December
      31, 2006 ,
      respectively. The balance sheet amounts with the exception of equity at September
      30, 2007 were
      translated 7.50 RMB to $1.00 USD as compared to 7.80 RMB at December
      31, 2006 .
      The
      equity accounts were stated at their historical rate. The average translation
      rates applied to income statement accounts for the periods ended September
      30, 2007 and 2006 were
      7.65 RMB and 8.00 RMB to $1.00 USD, respectively.




Statement
      of cash
      flows




In
      accordance with Statement of Financial Accounting Standards No. 95, "Statement
      of Cash Flows," cash flows from the Company's operations is calculated based
      upon the local currencies. As a result, amounts related to assets and
      liabilities reported on the statement of cash flows will not necessarily agree
      with changes in the corresponding balances on the balance sheet.




-
          13 -


HARBIN
        ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2007
 (UNAUDITED)
  Change
      in accounting for registration rights penalties





On
      January 1, 2007, the Company adopted FASB Staff Position No. EITF 00-19-2,
      “Accounting for Registration Payment Arrangements” (“FSP EITF 00-19-2”). FSP
      EITF 00-19-2 requires contingent obligations under a registration payment
      arrangement to be recognized and measured in accordance with SFAS No. 5,
“Accounting for Contingencies” (“FAS 5”). FAS 5 requires loss contingencies to
      be accrued and expensed if they are probable and reasonably
      estimable.





In
      connection with the convertible debt and warrants issued in October 2006, the
      Company filed a registration statement with the Securities and Exchange
      Commission to register for resale the common shares underlying the convertible
      debt and warrants. Initially, pursuant to EITF 00-19, “Accounting for Derivative
      Financial Instruments Indexed to, and Potentially Settle in, a Company’s Own
      Stock,” the existence of contingent cash penalties in the Registration Rights
      Agreement triggered derivative accounting treatment.





As
      a
      result the Company recorded the warrants as a liability at their fair value
      on
      the date they were issued and then marked them to market each subsequent
      reporting period. Upon adoption of FSP EITF 00-19-2, any warrants originally
      classified as a liability under EITF 00-19 that would have been classified
      as
      equity without regard to the registration payment arrangement should be
      reclassified. The transition to the accounting treatment under FSP EITF 00-19-2
      is shown in the accompanying financial statements through 1) a cumulative-effect
      adjustment to the opening balance of retained earnings, as of January 1, 2007
      and 2) reclassifying the warrants to equity at their fair value on the date
      of
      grant. The adjustment totaled $6,353,033 and was equal to the change in fair
      value of the warrants between October 6, 2006, the date the warrants were
      issued, and December 31, 2006, the last reporting period. Additionally, the
      warrants were reclassified as equity at $22,921,113, their fair value on October
      6, 2006. The adoption of FSP EITF 00-19-2 did not have an impact on prior year
      financial statements.





Recently
      issued accounting pronouncements





In
      September 2006, FASB issued SFAS 157 ‘Fair Value Measurements’. This Statement
      defines fair value, establishes a framework for measuring fair value in
      generally accepted accounting principles (GAAP), and expands disclosures about
      fair value measurements. This Statement applies under other accounting
      pronouncements that require or permit fair value measurements, the Board having
      previously concluded in those accounting pronouncements that fair value is
      the
      relevant measurement attribute. Accordingly, this Statement does not require
      any
      new fair value measurements. However, for some entities, the application of
      this
      Statement will change current practice. This Statement is effective for
      financial statements issued for fiscal years beginning after November 15, 2007,
      and interim periods within those fiscal years. Management is currently
      evaluating the effect of this pronouncement on financial
      statements.




-
          14 -


HARBIN
        ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2007
 (UNAUDITED)
  In
      December 2006, the FASB issued FASB Staff Position No. EITF 00-19-2 “Accounting
      for Registration Payment Arrangements” (“FSP EITF 00-19-2”), which addresses an
      issuer’s accounting and disclosures relating to registration payment
      arrangements. In connection with issuance of Units in the private placement
      in
      February 2007, the Company has agreed to register the shares underlying the
      Units.





In
      accordance with FSP EITF 00-19-2, the registration payment arrangements are
      accounted for as an instrument separate and apart from the related securities
      and will be accounted for in accordance with Statement of Financial Accounting
      Standards No. 5 “Accounting for Contingencies,” accruing a liability if payment
      is probable and the amount can be reasonably estimated.





This
      FSP
      also requires certain disclosures regarding registration payment arrangements
      and liabilities recorded for such purposes. This FSP is immediately effective
      for registration payment arrangements entered into or modified after December
      21, 2006. The guidance of this FSP is effective for fiscal years beginning
      after
      December 15, 2006, and interim periods within those fiscal years for
      registration payment arrangements entered into prior to December 21, 2006.
      This
      FSP requires adoption by reporting a change in accounting principle through
      a
      cumulative-effect adjustment to the opening balance of retained earnings as
      of
      the first interim period of the year in which this FSP is initially applied.
      The
      Company recorded an adjustment to retained earnings totaling $6,353,033 which
      equaled the gain recognized for the change in fair value of the warrants between
      the date the warrants were issued and December 31, 2006.





In
      February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
      Assets and Financial Liabilities—Including an amendment of FASB Statement No.
      115 (“SFAS 159”). SFAS 159 permits companies to choose to measure many financial
      instruments and certain other items at fair value that  are
      not
      currently required to be measured at fair value. The objective of SFAS 159
      is to
      provide opportunities to mitigate volatility in reported earnings caused
      by  measuring
      related assets and liabilities differently without having to apply hedge
      accounting provisions. SFAS 159 also establishes presentation and
      disclosure  requirements
      designed to facilitate comparisons between companies that choose different
      measurement attributes for similar types of assets and liabilities.
      SFAS  159
      will
      be effective in the first quarter of fiscal 2009. The Company is evaluating
      the
      impact that this statement will have on its consolidated financial  statements.





In
      June
      2007, the
      FASB
      issued FASB Staff Position No. EITF 07-3, “Accounting for Nonrefundable Advance
      Payments for Goods or Services Received for use in Future Research and
      Development Activities” (“FSP EITF 07-3”), which addresses whether nonrefundable
      advance payments for goods or services that used or rendered for research and
      development activities should be expensed when the advance payment is made
      or
      when the research and development activity has been performed. Management is
      currently evaluating the effect of this pronouncement on financial
      statements.




-
          15 -


HARBIN
        ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2007
 (UNAUDITED)
  Reclassifications **





Certain
      prior period amounts have been reclassified to conform to the current period
      presentation. These reclassifications have no effect on net income or cash
      flows.





**Note
      3 – Earnings per share**





The
      Company reports earnings per share in accordance with the provisions of SFAS
      No.
      128, “Earnings Per Share.” SFAS No. 128 requires presentation of basic and
      diluted earnings per share in conjunction with the disclosure of the methodology
      used in computing such earnings per share. Basic earnings per share excludes
      dilution and is computed by dividing
      income available to common stockholders by the weighted average common shares
      outstanding during the period. Diluted earnings per share takes into account
      the
      potential dilution that could occur if securities or other contracts to issue
      common stock were exercised and converted into common stock.





The
      following is a reconciliation of the basic and diluted earnings per share
      computations for the periods ended September
      30, 2007 and 2006 :




2007
            
            2006For
                the nine months endedSeptember
                30, 2007and2006Net
                income for basic and diluted earnings per share
            
            $
            12,724,441
            
            $
            11,755,399Weighted
                average shares used in basic computation
            
            
            16,810,065
            
            
            16,600,451Diluted
                effect of stock options and warrants
            
            
            1,405,346
            
            
            2,634,683Weighted
                average shares used in diluted computation
            
            
            18,215,411
            
            
            19,235,134Earnings
                per share:Basic
            
            $
            0.76
            
            $
            0.71Diluted
            
            $
            0.70
            
            $
            0.61For
                the three months endedSeptember
                30, 2007and2006Net
                income for basic and diluted earnings per share
            
            $
            4,764,222
            
            $
            4,283,156Weighted
                average shares used in basic computation
            
            
            17,226,880
            
            
            16,600,451Diluted
                effect of stock options and warrants
            
            
            1,405,366
            
            
            894,803Weighted
                average shares used in diluted computation
            
            
            18,632,246
            
            
            17,495,254Earnings
                per share:Basic
            
            $
            0.28
            
            $
            0.26Diluted
            
            $
            0.26
            
            $
            0.24




-
          16 -


HARBIN
        ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2007
 (UNAUDITED)
  At September
      30, 2007 ,
      all
      stock options and warrants have been included in the diluted earnings per share
      calculation.





**Note
      4 – Inventories**





Inventories
      consist of the following at September
      30, 2007 and December
      31, 2006 :





2007
            
            2006Raw
                and packing materials
            
            $
            811,174
            
            $
            432,998Work
                in process
            
            
            682,144
            
            
            120,367Finished
                goods
            
            
            383,644
            
            
            29,922Total
            
            $
            1,876,962
            
            $
            583,287





**Note
      5 – Plant and equipment**





Plant
      and
      equipment consist of the following at September
      30, 2007 and December
      31, 2006 :





2007
            
            2006Buildings
            
            $
            5,594,905
            
            $
            5,396,163Office
                equipment
            
            
            344,442
            
            
            203,188Production
                equipment
            
            
            4,181,993
            
            
            803,854Vehicles
            
            
            267,514
            
            
            129,938Construction
                in progress
            
            
            9,315,650
            
            
            3,477,322Total:
            
            
            19,704,504
            
            
            10,010,465Less:
                accumulated depreciation
            
            
            (1,204,601
            )
            
            (790,931
            )Property
                and equipment, net
            
            $
            18,499,903
            
            $
            9,219,534





Construction
      in progress represents labor costs, material, capitalized interest incurred
      in
      connection with the construction of new plant facility in Shanghai and the
      construction and installation of manufacturing equipment in Harbin manufacture
      plan. The management expects that the construction of the new plant will be
      completed by the end of 2008. No depreciation is provided for construction
      in
      progress until such time until the constructions are completed and are placed
      into service. Those assets will subject to the depreciation based upon the
      nature of the fixed assets.




-
          17 -


HARBIN
      ELECTRIC, INC. AND SUBSIDIARIES





NOTES
      TO
      THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
      30, 2007


(UNAUDITED)


Depreciation
      expense for the nine months ended September
      30, 2007 and 2006 amounted
      to $505,270 and $180,438, respectively. Depreciation expense for the three
      months ended September
      30, 2007 and 2006 amounted
      to $295,871 and $102,780, respectively.





As
      of
      September 30, 2007, a total of $297,489 has been capitalized into construction
      in progress.





**Note
      6 - Intangible assets**





Land
      use
      rights - all land in the People’s Republic of China is government owned and
      cannot be sold to any individual or company. However, the government grants
      the
      user a “land use right” (the Right) to use the land. The Company acquired land
      use rights during 2005 for of $344,804. The Company has the right to use the
      land for 50 years and amortizes the Right on a straight line basis over 50
      years.





Patents
–
      capitalized patent costs represent legal costs incurred to establish patents
      and
      the portion of the acquisition price paid attributed to patents upon the assets
      acquisition in July 16, 2007 as discussed further in Note 17. Capitalized patent
      costs are amortized on a straight method over the related patent terms from
      6 to
      10 years.





The
      Company evaluates intangible assets for impairment, at least on an annual basis
      and whenever events or changes in circumstances indicate that the carrying
      value
      may not be recoverable from its estimated future cash flows. Recoverability
      of
      intangible assets, other long-lived assets, and goodwill is measured by
      comparing their net book value to the related projected undiscounted cash flows
      from these assets, considering a number of factors including past operating
      results, budgets, economic projections, market trends and product development
      cycles. If the net book value of the asset exceeds the related undiscounted
      cash
      flows, the asset is considered impaired, and a second test is performed to
      measure the amount of impairment loss. As of September
      30, 2007 ,
      no
      impairment of intangible assets has been identified or recorded.





Net
      intangible assets at September
      30, 2007 and December
      31, 2006 were as
      follows:





2007
            
            2006Land
                use rights
            
            $
            383,805
            
            $
            356,484Patents
            
            
            6,047,675
            
            
            444,216Less:
                accumulated amortization
            
            
            (313,861
            )
            
            (160,363
            )Intangible
                assets, net
            
            $
            6,117,619
            
            $
            640,337





Amortization
      expense for the nine months ended September
      30, 2007 and 2006 amounted
      to $241,354 and
      $34,402, respectively. Amortization expense for the three months ended September
      30, 2007 and 2006 amounted
      to $194,050 and $34,402, respectively.




-
          18 -


HARBIN
      ELECTRIC, INC. AND SUBSIDIARIES





NOTES
      TO
      THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
      30, 2007


(UNAUDITED)


**Note
      7 – Advances to suppliers**





The
      Company makes advances to certain vendors’ inventory purchases, construction
      projects and research and development expenses. The advances on inventory
      purchases were $1,781,398 and $834,590 as of September
      30, 2007 and December
      31, 2006 ,
      respectively. Additionally, the Company made advances on equipment purchases
      totaling $12,922,994 at September
      30, 2007 and $0 as of December
      31, 2006 ,
      respectively.





**Note
      8 – Advance for intangible assets**





The
      advances for intangible assets as of September
      30, 2007 and December
      31, 2006 consist
      of the following:





2007
            
            2006Patent
                prepayment
            
            $
            -
            
            $
            192,300Land
                use right prepayment
            
            
            1,347,340
            
            
            1,294,820Advances
                on intangible assets
            
            $
            1,347,340
            
            $
            1,487,120





On
      September 8, 2006, HTFE entered into an agreement ("Land Use Agreement") with
      Shanghai Lingang Investment and Development Company Limited ("Shanghai Lingang")
      with respect to HTFE’s use of 40,800 square meters of State-owned land in the
      Shanghai Zhuqiao Airport Industrial Zone (the "Site").





The
      term
      of the land use agreement is 50 years and the aggregate amount that HTFE shall
      pay to Shanghai Lingang is approximately $2.54 million ("Fee"), 55% or
      $1,294,820 has been paid with the balance payable upon Shanghai Lingang's
      completion of certain regulatory applications on behalf of HTFE. The balance
      of
      the Fee is payable within seven days of receipt of a regulatory permit for
      work
      commencement. The Site will be used for industrial purposes. The Land Use
      Agreement provides that HTFE shall invest approximately $15 million in the
      Site
      through December 2008. This investment amount includes fees, improvement costs,
      constructing a factory building and installing necessary equipment. HTFE shall
      register a Sino-foreign joint venture company at the location of Shanghai
      Lingang, with taxes payable at the same location. HTFE has agreed to compensate
      Shanghai Lingang for certain local taxes due to the local tax authority in
      connection with applicable tax generation requirements. As of September 30,
      2007, the application of the land use lease is still in process.





**Note
      9 – Other assets**





Other
      assets as of September
      30, 2007 and December
      31, 2006 consist
      of the following:





-
          19 -


HARBIN
        ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2007
 (UNAUDITED)


2007
            
            2006Research
                and development prepayment
            
            $
            500,424
            
            $
            1,098,857Deferred
                expenses
            
            
            7,584
            
            
            2,982Total
            
            $
            508,008
            
            $
            1,101,839





On
      August
      21, 2006, HTFE entered into a joint research and development agreement (the
      “R&D Agreement”) with the Institute of Electrical Engineering of the Chinese
      Academy of Sciences (“IEECAS”) to produce a train system to be tested at the
      Beijing Airport railway line in the People’s Republic of China (“PRC”) by the
      end of 2008. The Agreement provides that the term of the project shall commence
      on August 2006 and terminate in early 2009. The R&D Agreement provides for a
      budget of approximately $3.13 million (RMB 25 million), consisting of $1.88
      million (RMB 15 million) to be invested by HTFE and the remainder to be invested
      by IEECAS. Of this amount, approximately $1,282,000 (RMB 10 million) has been
      invested to date by HTFE. The balance of approximately $0.625 million (RMB
      5
      million) will be invested prior to termination of the agreement at the end
      of
      2008 as testing and evaluation occurs.





The
      research and development prepayment has been amortized based on the process
      of
      the service occurred under SFAS 2 and EITF 07-3. Total of $591,073 has incurred
      as research and development expense for the nine months ended September 30,
      2007.





Interest
      receivable represents the interest that the Company accrued on the certificate
      deposit. The Company expects to receive the interest at the end of
      2007.





**Note
      10** **–
      Additional product sales information**





The
      Company has a single operating segment. Majority of the Company’s revenue were
      generated from local sales. Summarized
      financial information concerning the Company’s revenues based on geographic area for
      the
      nine months ended September 30, 2007 and 2006 are as following:





2007
            
            2006China
            
            $
            40,801,406
            
            $
            28,274,856International
            
            
            5,314,539
            
            
            132,200Total
            
            $
            46,115,945
            
            $
            28,407,056





**Note
      11 – Financing**





On
      August
      29, 2006, the Company, Citadel Equity Fund Ltd. (“Citadel”) and Merrill Lynch
      International (“Merrill Lynch” and, together with Citadel, the “Investors”)
      entered into a financing term sheet dated as of August 2, 2006 (the “Term
      Sheet”). The Term Sheet relates to the proposed issuance of Senior Secured Notes
      in a purchase agreement (the “Purchase Agreement”) relating to the purchase and
      sale of (a) $50 million aggregate principal amount of the Company's Guaranteed
      Senior Secured Floating Rate Notes (collectively, the “Notes”) and (b) fully
      detachable warrants (the “Warrants”) to purchase an aggregate of 3,487,368
      shares of our common stock. The transaction closed on August 30,
      2006.




-
          20 -


HARBIN
        ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2007
 (UNAUDITED)
  The
      Notes
      are governed by an indenture, dated August 30, 2006, entered into among the
      Company, as guarantor, and The Bank of New York, as trustee for the Notes (the
      “Indenture”). Of the $50 million aggregate principal amount of the Notes,
      Citadel subscribed to $38 million of the principal amount of the Notes, which
      mature on September 1, 2012 (the “2012 Notes”), and Merrill Lynch subscribed to
      $12 million of the principal amount of the Notes, which mature on September
      1,
      2010 (the “2010 Notes”). Pursuant to the indenture, our subsidiary AEM has
      agreed, and all of the Company’s other existing and future subsidiaries (other
      than subsidiaries domiciled in the People's Republic of China) are obligated,
      to
      guarantee, on a senior secured basis, to the Investors and to the trustee the
      payment and performance of our obligations.





The
      2010
      Notes bear interest, payable semi-annually in arrears commencing March 1, 2007,
      at a rate equal to LIBOR (approximately 5.3% at September 30, 2007), plus 4.75%.
      The 2010 Notes bear an additional 4% interest on any overdue principal and
      premium, if any, including interest on overdue interest, to the extent permitted
      by law.





The
      2010
      Notes are redeemable at the option of the Company, in whole but not in part,
      at
      any time after September 1, 2007, initially at 106% of the principal amount
      thereof and declining to 100% of the principal amount on September 1, 2009.
      The
      2010 Notes are subject to mandatory redemption semi-annually commencing March
      1,
      2008 in the principal amount $2,000,000 at price equal to 100% of such principal
      amount.





The
      2012
      Notes bear interest, payable semi-annually in arrears commencing March 1, 2007,
      at a rate equal to LIBOR plus 3.35%. See below for discussion of swap agreement
      changing the variable interest to 7.2% fixed. The 2012 Notes bear an additional
      4% interest on any overdue principal and premium, if any, including interest
      on
      overdue interest, to the extent permitted by law. The 2012 Notes are redeemable
      at the option of the Company, in whole but not in part, at any time after
      September 1, 2007, initially at 106% of the principal amount thereof and
      declining to 100% of the principal amount on September 1, 2011. The 2012 Notes
      are subject to mandatory redemption semi-annually commencing September 1, 2008
      in the principal amount $2,400,000 on September 1, 2009, $3,800,000 on March
      1,
      2010, $9,900,000 on September 1, 2010 and March 1, 2011, and $4,000,000 on
      September 1, 2011 and March 1, 2012, in each instance at price equal to 100%
      of
      such principal amount. Holders of the 2012 Notes may require the Company to
      repurchase such Notes at 100% of the principal amount thereof at any time after
      September 1, 2011.





Upon
      a
      Change of Control (as defined in the indenture), holders of the Notes may
      require the Company to repurchase any or all such Notes at a price equal to
      102.5% of the principal amount thereof. The Company is required to offer to
      purchase Notes at a price equal to 100% of the principal amount thereof with
      the
      proceeds of certain asset sales.




-
          21 -


HARBIN
        ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2007
 (UNAUDITED)
  The
      Indenture contains numerous affirmative and negative covenants. The Indenture
      requires the payment of liquidated damages in the amount of (i) $750,000 if
      the
      Company’s common stock shall not have been approved for listing on the NASDAQ
      Global Market or the NASDAQ Capital Market by April 1, 2007 and if such listing
      is not being maintained as of such date, (ii) $1,500,000 if the Company’s common
      stock shall not have been approved for listing on the NASDAQ Global Market
      or
      the NASDAQ Capital Market by July 1, 2007 and if such listing is not being
      maintained as of such date, (iii) $2,500,000 if the Company shall not have
      engaged a permitted independent accounting firm by January 1 of each year and
      such engagement is in effect as of March 1 of such year, commencing with 2007;
      and (iv) $1,200,000 if a full time senior financial officer knowledgeable with
      respect to the capital markets in the United States and proficient in the
      English language shall not have been appointed within 120 days after August
      30,
      2006, with the same aggregate amount for each 120 day period thereafter during
      which such senior financial officer shall not have been appointed.





On
      December 21, 2006, the Company obtained a waiver from Citadel to waive any
      and
      all claims to liquidated damages that may otherwise have accrued prior to
      February 28, 2007 due to the Company’s failure to appoint a senior financial
      officer.





As
      security for the Notes, the Company and The Bank of New York, as collateral
      agent, entered into a share pledge agreement, dated August 30, 2006, to secure
      the Notes with all of the shares of AEM common stock held by the Company as
      collateral.





The
      Warrants are governed by a warrant agreement, dated August 30, 2006, between AEM
      and The Bank of New York, as warrant agent. The Warrants consist of (i) six-year
      warrants to purchase an aggregate of 2,192,308 shares of our common stock,
      at an
      exercise price of $7.80 per share (the “First Tranche 2012 Warrants”), (ii)
      six-year warrants to purchase an aggregate of 525,830 shares of our common
      stock
      at an exercise price of $10.84 per share (the “Second Tranche 2012 Warrants”)
      and (iii) three-year warrants to purchase an aggregate of 769,230 shares of
      our
      common stock at an exercise price of $7.80 per share (the “2009 Warrants”).





The
      First
      Tranche 2012 Warrants and the Second Tranche 2012 Warrants were issued to
      Citadel, and the 2009 Warrants were issued to Merrill. Each Warrant is
      exercisable at the option of the Warrant holder at any time through the maturity
      date of such Warrant.





The
      warrant agreements contain a cashless exercise provision. During the quarter
      ended September 30, 2007, the Company issued 531,650 shares of common stock
      in 2
      separate cashless transactions.




-
          22 -


HARBIN
        ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2007
 (UNAUDITED)


Warrantsexercised
            
            Exerciseprice
            
            Trade date
            
            Marketprice
            
            Sharesissued663,462
            
            $
            7.80
            
            August
              13, 2007
            
            $
            13.90
            
            
            291,160159,133
            
            $
            10.84
            
            August
              13, 2007
            
            $
            13.90
            
            
            35,490384,165
            
            $
            7.80
            
            September
              28, 2007
            
            $
            16.25
            
            
            205,000Total
            
            
            1,206,760
            
            
            
            
            
            
            
            
            
            
            531,650




In
      addition, Mr. Tianfu Yang and Citadel entered into a voting agreement, dated
      August 30, 2006, pursuant to which Mr. Yang agreed to vote his shares of the
      capital stock of the Company to elect up to two members of the Company’s board
      of directors designated by Citadel. On
      March
      19, 2007, Citadel exercised its right to terminate that certain Voting Agreement
      dated August 30, 2006. The Company incurred no termination expenses or penalties
      in connection with the termination of the Voting Agreement .





The
      Investors and Mr. Tianfu Yang also entered into a non-competition covenant
      and
      agreement, dated August 30, 2006, relating to Mr. Yang's employment as our
      Chief
      Executive Officer and his ability to engage in a business that is competitive
      with our business for so long as any of the Notes remain
      outstanding.





In
      connection with the issuance of the Notes, the Company agreed to file a shelf
      registration statement by March 30, 2007 covering the resale of the common
      stock
      underlying the Warrants. The registration statement was effective on February
      9,
      2007.





On
      January 1, 2007, the Company adopted FASB Staff Position No. EITF 00-19-2,
      “Accounting for Registration Payment Arrangements” (“FSP EITF 00-19-2”). FSP
      EITF 00-19-2 requires contingent obligations under a registration payment
      arrangement to be recognized and measured in accordance with SFAS No. 5,
“Accounting for Contingencies” (“FAS 5”). FAS 5 requires loss contingencies to
      be accrued and expensed if they are probable and reasonably estimable.





In
      connection with the convertible debt and warrants issued in August
      2006, the Company filed registration statement with the Securities and Exchange
      Commission (SEC) to register for resale the common shares underlying the
      convertible debt and warrants.  Initially,
      pursuant to EITF 00-19, “Accounting for Derivative Financial Instruments Indexed
      to, and Potentially Settle in, a Company’s Own Stock,” the existence of
      contingent cash penalties in the Registration Rights Agreement triggered
      derivative accounting treatment. As a result the Company recorded the warrants
      as a liability at their fair value on the date they were issued and then marked
      them to market each subsequent reporting period. Upon adoption of FSP EITF
      00-19-2, any warrants originally classified as a liability under EITF 00-19
      that
      would have been classified as equity, without regard to the registration payment
      arrangement, should be reclassified .




-
          23 -


HARBIN
        ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2007
 (UNAUDITED)


The
      transition to the accounting treatment under FSP EITF 00-19-2 is shown in the
      accompanying financial statements through 1) a cumulative-effect adjustment
      to
      the opening balance of retained earnings, as of January 1, 2007 and 2)
      reclassifying the warrants to equity at their fair value on the date of grant.
      The adjustment totaled $6,353,033 was equal to the change in fair value of
      the
      warrants between October 6, 2006, the date the warrants were issued, and
      December 31, 2006, the last reporting period. Additionally, the warrants were
      reclassified as equity at $22,921,113, their fair value on October 6, 2006.
      The
      adoption of FSP EITF 00-19-2 did not have an impact on prior year financial
      statements.





The
      fair
      value of the warrants upon issuance totaled $22,921,112, was initially treated
      as a discount to the carrying value of the debt, and would have been amortized
      over the life of the loan using the effective interest method. $3,399,099 and
      $1,510,711 was amortized to interest expense for the nine months ended September
      30, 2007 and for
      the year ended December
      31, 2006 ,
      respectively. As of September
      30, 2007 ,
      the
      unamortized debt discount totaled $18,011,302 .





2007
            
            2006Long-term
                debt:Principal
                amount
            
            $
            50,000,000
            
            $
            50,000,000Less
                unamortized discount
            
            
            (18,011,302
            )
            
            (21,410,401
            )Long-term
                debt, net of unamortized discount
            
            $
            31,988,698
            
            $
            28,589,599





Debt
      issuance costs totaled $2,954,625 ,
      are
      carried in other assets and are amortized over the life of the loan using the
      effective interest method. $554,551 was
      amortized to interest expense for the nine months ended September 30, 2007.
      As
      of September 30, 2007, the unamortized debt issuance costs totaled $2,183,661 .





Net
      interest expense for nine and three months ended September
      30, 2007 and 2006 was
      comprised of the following:




For the nine monthsended
                September 30,
            
            For the three monthsended
                September 30,2007
            
            2006
            
            2007
            
            2006Interest
                expense on debt issuance costs
            
            $
            554,551
            
            
            -
            
            $
            308,333
            
            
            -Interest
                expense
            
            
            3,178,578
            
            
            -
            
            
            1,603,459
            
            
            -Interest
                income earned on cash deposits
            
            
            (864,254
            )
            
            (57,602
            )
            
            (551,605
            )
            
            (26,569
            )Interest
                received on derivative instrument
            
            
            (554,602
            )
            
            -
            
            
            (256,965
            )
            
            -Amortization
                of debt discount
            
            
            3,399,099
            
            
            -
            
            
            1,133,033
            
            
            -Interest
                expense (income), net
            
            $
            5,713,372
            
            
            (57,602
            )
            $
            2,236,255
            
            
            (26,569
            )





**Note
      12 – Derivative instrument**





The
      Company's operations are exposed to a variety of global market risks, including
      the effect of changing interest rates. This exposure is managed, in part, with
      the use of financial derivatives. The Company uses financial derivatives only
      to
      hedge exposures in the ordinary course of business and dose not invest in
      derivative instruments for speculative purposes.




-
          24 -


HARBIN
        ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2007
 (UNAUDITED)
  Effective
      April 17, 2007, the Company entered into a cross currency swap agreement with
      Merrill Lynch exchanging the LIBOR plus 4.75% variable rate interest payable
      on
      the $38 million Merrill Lynch debt for 7.2% (3.6% semi-annually) fixed rate
      interest. The agreement requires semi-annual payments on March 1 and September
      1
      through the maturity of the agreement on September 1, 2012. Merrill Lynch
      required the Company to deposit $1,000,000 with them to secure the agreement.
      The deposit may be increased to $2,500,000 if the exchange rate for Renminbi
      to
      USD falls below 6.5, and to $4,000,000 if the exchange rate falls below 5.5.
      This swap is designated and qualified as a cash flow hedge.





The
      fair
      value of this swap agreement at April 02, 2007 (inception date) was a payable
      of
      $5,387,487, and at September 30, 2007 was a payable of $7,047,406. From the
      inception date to September 30, 2007, changes in fair value of the swap resulted
      in a increase in the liability and a loss to other comprehensive
      income of $1,659,919, net of taxes. During the nine months ended September
      30,
      2007, the Company received $554,602, which was recorded as a gain from
      derivative transactions. For nine
      months ended September 30, 2007, there were no amounts recorded in the
      consolidated statement of income in relation to this interest rate swap related
      to ineffectiveness.





**Note
      13 – Accumulated other comprehensive income**





The
      components of accumulated other comprehensive income as
      follows:




Accumulated
                other comprehensive income:Balance
                at January 1, 2006
            
            $
            997,466Foreign
                currency translation gain
            
            
            730,097Unrealized
                loss on investment
            
            
            (587,171
            )Balance
                at September 30, 2006
            
            
            1,140,392Foreign
                currency translation gain
            
            
            304,328Unrealized
                loss on investment
            
            
            587,171Balance
                at December 31, 2006
            
            
            2,031,891Foreign
                currency translation gain
            
            
            3,956,036Change
                in fair value of derivative instrument
            
            
            (7,047,406
            )Balance
                at September 30, 2007
            
            $
            (1,059,479
            )




**Note
      14 – Commitments and contingencies**





The
      Company enters into non-cancelable purchase commitments with its vendors. As
      of September
      30, 2007 and December
      31, 2006 ,
      the
      Company was obligated under the non cancelable commitments to purchase materials
      amounting to $2,303,514 and $1,130,000, respectively. These commitments are
      short-term and expire within one year. The Company has experienced no losses
      on
      these purchase commitments over the years.




-
          25 -


HARBIN
        ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2007
 (UNAUDITED)
  As
      discussed in more detail in Note 1, the Company entered into an agreement with
      Shelton Technology, LLC on April 9, 2007. Under the terms of the agreement,
      the
      Company is required to contribute $3,000,000 to AAG in 3 installments: $1.2
      million was paid on April 16, 2007. The Company will contribute $800,000 by
      May
      1, 2008 and $1,000,000 by March 31, 2009.





As
      discussed in Note 12, the Company entered into a swap agreement that required
      a
      $1,000,000 deposit to secure the transaction. If the exchange rate for Renminbi
      to US Dollars drops below certain levels, the Company will be required to
      deposit up to $4,000,000.





The
      Company is subject to a 5 year lease agreement dated February 1, 2004 for office
      space requiring monthly payments of $2,700. The agreement expires February
      2009.
      Rent expense for the nine months ended September 30, 2007 and 2006 amounted
      to
      $24,057 and $23,499, respectively. Total future minimum lease payments at
      September 30, 2007, are as follows:





Period ended September 30,
            
            Amount2008
            
            $
            32,0782009
            
            
            13,675Thereafter,
            
            
            -





**Note
      15 – Shareholders’ equity**





Warrants





Following
      is a summary of the warrant activity:


Outstanding
                  as of January 1, 2006
              
              
              480,000Granted
              
              
              3,487,368Forfeited
              
              
              -Exercised
              
              
              -Outstanding
                  as of December 31, 2006
              
              
              3,967,368Granted
              
              
              -Forfeited
              
              
              -Exercised
              
              
              (1,269,710
              )Outstanding
                  as of September 30, 2007
              
              
              2,697,658




-
          26 -


HARBIN
        ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2007
 (UNAUDITED)


Following
      is a summary of the status of warrants outstanding at September
      30, 2007 :


Outstanding
                  Warrants
              
              Exercisable
                  WarrantsExercise
                Price
              
              Number
              
              Average
                Remaining
                Contractual
                Life
              
              Average
                Exercise
                  Price
              
              Number
              
              Average
                Exercise
                Price$                       3.50
              
              
              417,500
              
              
              3.42
              
              $
              3.50
              
              
              417,500
              
              $
              3.50$                     10.84
              
              
              366,697
              
              
              5.17
              
              $
              10.84
              
              
              366,697
              
              $
              10.84$                       7.80
              
              
              1,528,846
              
              
              2.17
              
              $
              7.80
              
              
              1,528,846
              
              $
              7.80$                       7.80
              
              
              384,615
              
              
              2.14
              
              $
              7.80
              
              
              384,615
              
              $
              7.80Total
              
              
              2,697,658
              
              
              
              
              
              
              
              
              2,697,658




**Note
      16 – Options**





In
      May
      2005 the Board of Directors of the Company adopted and approved the 2005
      Stock Option Plan (the “Plan”) which authorized the issuance of up
      to 1,500,000 shares under the Plan.





Following
      is a summary of the stock option activity:


Options
                Outstanding
              
              Weighted
                Average
                Exercise
                Price
              
              Aggregate
                Intrinsic ValueOutstanding
                  as of January 1, 2006
              
              
              400,000
              
              $
              3.55
              
              $
              1,818,409Granted
              
              
              500,000
              
              
              8.10
              
              
              1,450,000Forfeited
              
              
              -
              
              
              -
              
              
              -Exercised
              
              
              -
              
              
              -
              
              
              -Outstanding
                  as of December 31, 2006
              
              
              900,000
              
              $
              6.11
              
              $
              3,052,500Granted
              
              
              25,000
              
              
              12.40
              
              
              -Forfeited
              
              
              -
              
              
              -
              
              
              -Exercised
              
              
              -
              
              
              -
              
              
              -Outstanding
                  as of September 30, 2007
              
              
              925,000
              
              $
              6.28
              
              $
              3,052,500




Following
      is a summary of the status of options outstanding at September
      30, 2007 :




Outstanding
                Option
            
            Exercisable
                OptionsExercise
              Price
            
            Number
            
            Average
              Remaining
              Contractual
              Life
            
            Average
              Exercise
              Price
            
            Number
            
            Average
              Exercise
              Price$                     3.10
            
            
            150,000
            
            
            2.84
            
            $
            3.10
            
            
            150,000
            
            $
            3.10$                     3.93
            
            
            250,000
            
            
            1.49
            
            $
            3.93
            
            
            150,000
            
            $
            3.93$                     8.10
            
            
            500,000
            
            
            3.85
            
            $
            8.10
            
            
            152,778
            
            $
            8.10$                   12.40
            
            
            25,000
            
            
            2.42
            
            $
            12.40
            
            
            2,087
            
            $
            12.40Total
            
            
            925,000
            
            
            
            
            
            
            
            
            454,865




-
          27 -


HARBIN
        ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2007
 (UNAUDITED)
  Significant
      assumptions used to estimate fair value





Under
      SFAS No 123R, the Company’s expected volatility assumption is based on the
      historical volatility of Company’s stock. The expected life assumption is
      primarily based on historical exercise patterns and employee post-vesting
      termination behavior. The risk-free interest rate for the expected term of
      the
      option is based on the U.S. Treasury yield curve in effect at the time of grant.





Stock
      compensation expense recognized in 2006 is based on awards expected to vest,
      and
      there were no estimated forfeitures as the Company has a short history of
      issuing options. SFAS No. 123R requires forfeitures to be estimated at the
      time of grant and revised in subsequent periods, if necessary, if actual
      forfeitures differ from those estimates.





**Note
      17 – Supplemental disclosure of cash flows**





The
      Company prepares its statements of cash flows using the indirect method as
      defined under the Financial Accounting Standard No. 95. A
      total
      of $194,250 has been reclassified from advance on intangible assets as of
      December 31, 2006 to intangible assets as of September 30, 2007 and has no
      effect on cash flow.





For
      the
      nine months ended September 30, 2007, the Company recorded stock based
      compensation expense amounting to $705,723.





On
      July
      19, 2007, the Company issued 473,354
      shares of common stock in
      valued
      at $6,500,000 plus $4,000,000 of cash as payment for part of the purchase price
      for certain assets acquired
      from Harbin Taifu Auto Electric Co., Ltd., The fair value of net assets acquired
      as follow:


AssessedItem
              
              Book value
              
              Fair ValueCurrent
                  assets
              
              $
              2,186,039
              
              $
              2,186,039Equipment
              
              
              2,987,640
              
              
              2,987,640Patent
                  rights
              
              
              1,223,522
              
              
              5,326,321Total
                  assets acquired
              
              $
              6,397,201
              
              $
              10,500,000




**Note
      18 –** **Employee
      pension**





The
      employee pension in Harbin generally includes two parts: the first part to
      be
      paid by the Company is 20% of the employees’ actual salary in the prior year. If
      the average salary falls below $1,165 for each individual, $1,165 will be used
      as the basis. The other part, paid by the employees, is 8% of actual salary
      with
      the same minimum requirement. The Company made $27,394 contributions of
      employment benefits, including pension in the period ended September 30, 2007.
      The Company made $10,767  in
      contributions of employment benefits, including pension in the period ended
      September 30, 2006.




-
          28 -


HARBIN
        ELECTRIC, INC. AND SUBSIDIARIES
 
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2007
 (UNAUDITED)
  **Note
      19 – Legal proceedings**





From
      time
      to time, the Company becomes involved in various lawsuits and legal proceedings
      which arise in the ordinary course of business.  Following is the summary
      of the current litigation as of September
      30, 2007 .




Leong
      Sing Lye v. Harbin Electric, Inc. United States District Court, District of
      Nevada, Case No. 2:06-CV-00796





In
      June
      2006, an action was filed against the Company by Leong Sing Lye in the United
      States District Court for the District of Nevada, seeking specific performance
      of the Company's alleged obligation to issue 228,000 shares of Common Stock
      and
      warrants to purchase 38,400 shares of common stock, or, in the alternative,
      the
      value of securities alleged to be owed to Mr. Lye under, or, monetary damages
      allegedly arising from, a so-called Appointment Agreement pursuant to which
      Mr.
      Lye alleges to have been appointed the Company's Consultant of Corporate
      Strategy, as well as court costs and reasonable attorneys' fees. The Company
      has
      filed an answer to Mr. Lye's complaint denying the material allegations thereof
      and a counterclaim against Mr. Lye for fraud and related claims. The Company
      intends to vigorously defend itself against Mr. Lye's claim, if not withdrawn,
      and pursue its counterclaim. The parties are in the discovery process. The
      Company has filed a motion for summary judgment to eliminate portions of Mr.
      Lye's case and Mr. Lye has filed a cross-motion. The parties await the Court's
      ruling on these matters. The Company does not believe that the ultimate outcome
      of this matter will have a material adverse effect on the Company.




-
          29 -







**Item
      1A. Risk Factors**




You
      should carefully consider these risk factors as each of these risks could
      adversely affect our business, operating results and financial condition.
      Additional risks and uncertainties not presently foreseeable to us may also
      impair our business operations. If any of the following risks actually occurs,
      our business, financial condition or operating results could be materially
      and
      adversely affected. In such case, the trading price of our common stock could
      decline, and you may lose all or part of your investment.




**GENERAL
      RISKS RELATING TO OUR BUSINESS**




**We
      need to manage growth in operations to maximize our potential growth and achieve
      our expected revenues.**




In
      order
      to maximize potential growth in our current and potential markets, we believe
      that we must expand our manufacturing and marketing operations. We experienced
      growth in our revenues of over sixty-two percent during the last fiscal year;
      however, there can be no assurance that we will be able to maintain such growth
      or any growth of our business. An expansion of our operations will place a
      significant strain on our management and our operational, accounting, and
      information systems. We expect that we will need to continue to improve our
      financial controls, operating procedures, and management information systems.
      We
      will also need to effectively train, motivate, and manage our employees. Our
      failure to manage our growth could disrupt our operations and ultimately prevent
      us from generating the revenues we expect.




**We
      may require additional financing in the future and a failure to obtain such
      required financing will inhibit our ability to grow.**




The
      continued growth of our business may require additional funding from time to
      time. Funding would be used for general corporate purposes. General corporate
      purposes may include acquisitions, investments, repayment of debt, capital
      expenditures, repurchase of our capital stock and any other purposes that we
      may
      specify in any prospectus supplement. Obtaining additional funding would be
      subject to a number of factors including market conditions, operational
      performance and investor sentiment, many of which are outside of our control.
      These factors may make the timing, amount, terms and conditions of additional
      funding unattractive, or unavailable, to us.





**The
      terms of any future financing may adversely affect your interest as
      stockholders.**





If
      we
      require additional financing in the future, we may be required to incur
      indebtedness or issue equity securities, the terms of which may adversely affect
      your interests in the Company. For example, the issuance of additional
      indebtedness may be senior in right of payment to your shares upon liquidation
      of the Company. In addition, indebtedness may be under terms that make the
      operation of our business more difficult because the lender’s consent will be
      required before we take certain actions. Similarly the terms of any equity
      securities we issue may be senior in right of payment of dividends to your
      common stock and may contain superior rights and other rights as compared to
      your common stock. Further, any such issuance of equity securities may dilute
      your interest in the Company.


-
          30 -




**Covenants
      in our debt instruments restrict or prohibit our ability to engage in or enter
      into a variety of transactions.**




The
      indenture governing our Notes contains various covenants that may limit our
      discretion in operating our business. In particular, we are limited in our
      ability to merge, consolidate or transfer substantially all of our assets,
      issue
      preferred stock of subsidiaries and create liens on our assets to secure debt.
      In addition, if there is default, and we do not maintain certain financial
      covenants or we do not maintain borrowing availability in excess of certain
      pre-determined levels, we may be unable to incur additional indebtedness, make
      restricted payments (including paying cash dividends on our capital stock)
      or
      redeem or repurchase our capital stock.




The
      indenture governing our Notes requires us to maintain certain financial ratios
      and limits our ability to make capital expenditures. These covenants and ratios
      could have an adverse effect on our business by limiting our ability to take
      advantage of financing, merger and acquisition or other corporate opportunities
      and to fund our operations. Any future debt could also contain financial and
      other covenants more restrictive than those imposed under the indenture
      governing our Notes.





**Our
      debt may have significant consequences, and cash flows and capital resources
      may
      be insufficient to make required payments on our substantial indebtedness and
      future indebtedness.**





We
      have a
      substantial amount of debt. As of September 30,
      2007, we had approximately $2.6 million of total current liabilities, in
      addition to $50 million outstanding under our indenture relating to the Notes
      issued in August 2006. Our substantial debt could have important consequences
      to
      you. For example, it could:




-
                payments on our indebtedness, which could reduce the availability
                of our
                cash flow to fund future working capital, capital expenditures,
                acquisitions and other general corporate
                purposes;




-
                limit our ability to obtain additional financing for working capital,
                capital expenditures, and other general corporate
                requirements;




-
                expose us to interest rate fluctuations because the interest rate
                is
                variable;




-
                increase our vulnerability to general adverse economic and industry
                conditions;




-
                require us to sell assets to reduce indebtedness or influence our
                decisions about whether to do so;




-
                restrict us from making strategic acquisitions or pursuing business
                opportunities;




-
                limit our flexibility in planning for, or reacting to, changes in
                our
                business and the industry in which we
                operate;




-
                limit, along with the financial and other restrictive covenants in
                our
                indebtedness, among other things, our ability to borrow additional
                funds;
                and




-
                place us at a competitive disadvantage compared to competitors that
                may
                have proportionately less debt.




In
      addition, our ability to make scheduled payments or refinance our obligations
      depends on our successful financial and operating performance, cash flows,
      and
      capital resources, which in turn depend upon prevailing economic conditions
      and
      certain financial, business, and other factors, many of which are beyond our
      control. If our cash flows and capital resources are insufficient to fund our
      debt obligations, we may be forced to reduce or delay capital expenditures,
      sell
      material assets or operations, obtain additional capital, restructure our debt,
      or declare bankruptcy. In the event that we are required to dispose of material
      assets or operations to meet our debt service and other obligations, the value
      realized on such assets or operations will depend on market conditions and
      the
      availability of buyers. Accordingly, we may be forced to sell at an unfavorable
      price. Furthermore, our obligations under various debt instruments are secured
      by our equity interests in Advanced Electric Motors, Inc. These security
      interests may limit our ability to dispose of material assets or operations.
      We
      also may not be able to restructure our debt on favorable economic terms, if
      at
      all.


-
          31 -




**We
      do not anticipate paying cash dividends on our common
      stock.**




We
      have
      never paid cash dividends on our common stock and do not anticipate paying
      cash
      dividends in the foreseeable future. We intend to follow a policy of retaining
      all of our earnings, if any, to finance development and expansion of our
      business.





**We
      may not be able to adequately protect and maintain our intellectual property.**




Our
      success will depend on our ability to continue to develop and market linear
      motors and other motor products. While we have been granted four patents in
      China relating to linear motor applications, we currently have not applied
      for
      patents for our technical processes and designs, as we believe an application
      for such patents would result in public knowledge of our proprietary technology
      and designs.




**Because
      of our dependence on a few key customers, the loss of any key customer could
      cause a significant decline in our revenues.**




Five
      major customers accounted for 77% of the net revenue for the period ended
      September 30, 2007. The loss of any of our major customers, or a significant
      reduction in sales to any such customers, would adversely affect our
      revenues.




**We
      depend on the supply of raw materials, and any adverse changes in such supply
      or
      the costs of raw materials may adversely affect our
      operations.**




Five
      major vendors provided approximately 82% of the Company’s purchases of raw
      materials for the period ended September 30, 2007. We currently obtain most
      of
      our raw materials from Shanghai KuiSheng Mechanical & Electrical Company,
      Harbin Longjiang Mould Company, and Jiangyin Huaming General Cabel Co. Any
      material change in the spot and forward rates could have a material adverse
      effect on the cost of our raw materials and on our operations. In addition,
      if
      we need alternative sources for key component parts for any reason, these
      component parts may not be immediately available to us. If alternative suppliers
      are not immediately available, we will have to identify and qualify alternative
      suppliers, and production of these components may be delayed. We may not be
      able
      to find an adequate alternative supplier in a reasonable time period, or on
      commercially acceptable terms, if at all. Shipments of affected products have
      been limited or delayed as a result of such problems in the past, and similar
      problems could occur in the future. Our inability to obtain our key source
      supplies for the manufacture of our products may require us to delay shipments
      of products, harm customer relationships or force us to curtail or cease
      operations.





**Our
      success depends on our management team and other key personnel, the loss of
      any
      of whom could disrupt our business operations.**




Our
      future success will depend in substantial part on the continued service of
      our
      senior management, including Mr. Tianfu Yang, our Chairman and Chief Executive
      Officer, Mr. Xu Suofei, our Vice President and Board Member, Mr. Tianli Yang,
      our Vice President, and Mr. Zedong Xu, our Chief Financial Officer. The loss
      of
      the services of one or more of our key personnel could impede implementation
      of
      our business plan and result in reduced profitability. We do not carry key
      person life insurance on any of our officers or employees. Our future success
      will also depend on the continued ability to attract, retain and motivate highly
      qualified technical sales and marketing customer support.


-
          32 -


Because
      of the rapid growth of the economy in China, competition for qualified personnel
      is intense. We cannot assure you that we will be able to retain our key
      personnel or that we will be able to attract, assimilate or retain qualified
      personnel in the future.





**Our
      directors and officers control a majority of our common stock and, as a result,
      they may exercise voting control and be able to take actions that may be adverse
      to your interests.**





Our
      directors and executive officers, directly or through entities that they
      control, currently beneficially own, as a group, approximately 70% of our issued
      and outstanding common stock as of September 30, 2007. This significant
      concentration of share ownership may adversely affect the trading price of
      our
      common stock because investors often perceive a disadvantage in owning shares
      in
      a company with just one or several controlling stockholders. Furthermore, our
      directors and officers, as a group, have the ability to significantly influence
      or control the outcome of all matters requiring stockholder approval, including
      the election of directors and approval of significant corporate transactions,
      such as mergers, consolidations or the sale of substantially all of our assets.
      This concentration of ownership may have the effect of delaying or preventing
      a
      change of control, including a merger, consolidation or other business
      combination involving us, or discouraging a potential acquirer from making
      a
      tender offer or otherwise attempting to obtain control.




**RISKS
      RELATING TO DOING BUSINESS IN THE PEOPLE’S REPUBLIC OF
      CHINA**





**China’s
      economic policies could adversely affect our business.**





Substantially
      all of our assets are located in China and substantially all of our revenue
      is
      derived from our operations in China. Accordingly, our results of operations
      and
      prospects are subject, to a significant extent, to the economic, political
      and
      legal developments in China.





While
      China’s economy has experienced a significant growth in the past twenty years,
      growth has been uneven, both geographically and among various sectors of the
      economy. The Chinese government has implemented various measures to encourage
      economic growth and guide the allocation of resources. Some of these measures
      benefit the overall economy of China, but may also have a negative effect on
      us.
      For example, our operating results and financial condition may be adversely
      affected by the government control over capital investments or changes in tax
      regulations.




The
      economy of China has been transitioning from a planned economy to a more
      market-oriented economy. In recent years the Chinese government has implemented
      measures emphasizing the utilization of market forces for economic reform and
      the reduction of state ownership of productive assets and the establishment
      of
      corporate governance in business enterprises; however, a substantial portion
      of
      productive assets in China are still owned by the Chinese government. In
      addition, the Chinese government continues to play a significant role in
      regulating industry development by imposing industrial policies. It also
      exercises significant control over China’s economic growth through the
      allocation of resources, controlling payment of foreign currency-denominated
      obligations, setting monetary policy and providing preferential treatment to
      particular industries or companies.


-
          33 -





**Capital
      outflow policies in the People’s Republic of China may hamper our ability to
      remit income to the United States.**





The
      PRC
      has adopted currency and capital transfer regulations. These regulations may
      require that we comply with complex regulations for the movement of capital.
      Although we believe that we are currently in compliance with these regulations,
      should these regulations or the interpretation of them by courts or regulatory
      agencies change we may not be able to remit all income earned and proceeds
      received in connection with our operations or from the sale of our operating
      subsidiary to the United States or to our stockholders. Please see “Description
      of Business - PRC Regulations.”




**If
      preferential tax concessions granted by the PRC government are changed or
      expire, our financial results and results of operations would be materially
      and
      adversely affected.**




Our
      results of operation may be adversely affected by changes to or expiration
      of
      preferential tax concessions that our subsidiary in the PRC currently enjoys.
      The statutory tax rate generally applicable to domestic Chinese companies is
      33%. A reduced income tax rate of 15% may be possible for productive foreign
      investment enterprises in the Economic and Technological Development Zones
      and
      for enterprises engaged in production or business operations in the Special
      Economic Zones. As a result of preferential tax rate incentives, our operations
      have been subject to relatively low tax liabilities. The estimated tax savings
      for the nine months ended September 30, 2007 and 2006 without preferential
      tax
      treatment amounted to approximately $7.4 million and $3.7 million,
      respectively.





Tax
      laws
      in China are subject to interpretations by relevant tax authorities. The
      preferential tax treatment may not remain in effect or may change, in which
      case
      we may be required to pay the higher income tax rate generally applicable to
      Chinese companies, or such other rate as is required by the laws of
      China.





Beginning
      January 1, 2008, the new Chinese Enterprise Income Tax (“EIT”) law will replace
      the existing laws for Domestic Enterprises (“DES”) and Foreign Invested
      Enterprises (“FIEs”). The new standard EIT rate of 25% will replace the 33% rate
      currently applicable to both DES and FIEs.




**The
      legal authorities in China are in the process of evaluating heretofore tax
      and
      fee benefits provided to foreign investors and companies to encourage
      development within the country such that these benefits may be lessened or
      removed with the consequence that expenses may rise impacting margins and net
      income.**




The
      legal
      authorities are evaluating tax and fee benefits that have been available to
      foreign investors and companies operating in China and tax holidays for new
      enterprises. It is anticipated, in the near term, there are going to be changes
      that substantially reduce or eliminate many, if not all, the tax and other
      governmental fee advantages that heretofore have been available to foreign
      entities and newly created entities whether or not such new entities are
      foreign. The goal is to institute greater equalization of tax and government
      fee
      treatment of all corporate and similar entities in China. China is being
      encouraged to create this more equal treatment because of its WTO obligations
      and public opinion within China. There may be phase-ins of various taxes and
      fees for entities that currently benefit from either no or lower tax rates
      and
      fees compared to wholly Chinese companies and entities, but there can be no
      assurance of this. Even if there are phase-in periods, the length of such
      periods is not known. Overall, it is expected that the cost of operating in
      China will increase for those companies and entities that have had various
      tax
      and fee advantages in the past.


-
          34 -





**Fluctuations
      in the value of the RMB could materially affect our financial condition and
      results of operations.**




The
      value
      of the RMB against the U.S. dollar and other currencies may fluctuate and is
      affected by, among other things, changes in the PRC’s political and economic
      conditions. As the majority of our net revenue is denominated in RMB, any
      significant revaluation of the RMB may materially and adversely affect our
      cash
      flows, revenues and financial condition. For example, to the extent that we
      need
      to convert U.S. dollars we receive from an offering of our securities into
      RMB
      for our operations, appreciation of the RMB against the U.S. dollar could have
      a
      material adverse effect on our business, financial condition and results of
      operations. Conversely, if we decide to convert our RMB into U.S. dollars for
      the purpose of making payments for business purposes and the U.S. dollar
      appreciates against the RMB, the U.S. dollar equivalent of the RMB we convert
      would be reduced. In addition, the depreciation of significant U.S. dollar
      denominated assets could result in a charge to our income statement and a
      reduction in the value of these assets.





On
      July
      21, 2005, the PRC government changed its policy of tying the value of the RMB
      to
      the U.S. dollar. Under the new policy, the RMB is permitted to fluctuate within
      a narrow and managed band against a basket of certain foreign currencies. This
      change in policy has resulted in an approximately 3.0% appreciation of the
      RMB
      against the U.S. dollar. While the international reaction to the RMB revaluation
      generally has been positive, there remains significant international pressure
      on
      the PRC government to adopt an even more flexible currency policy, which could
      result in a further and more significant appreciation of the RMB against the
      U.S. dollar.





**We
      may experience currency fluctuation and longer exchange rate payment
      cycles.**





The
      local
      currencies in the countries in which we sell our products may fluctuate in
      value
      in relation to other currencies. Such fluctuations may affect the costs of
      our
      products sold and the value of our local currency profits. While we are not
      conducting any meaningful operations in countries other than China at the
      present time, we may expand to other countries and may then have an increased
      risk of exposure of our business to currency fluctuation.




**We
      may face obstacles from the Communist system in the PRC.**





Foreign
      companies conducting operations in the PRC face significant political, economic
      and legal risks. The Communist regime in the PRC, including a stifling
      bureaucracy, may hinder Western investment.




**We
      may have difficulty establishing adequate management, legal and financial
      controls in the PRC.**





The
      PRC
      historically has been deficient in Western style management and financial
      reporting concepts and practices, as well as in modern banking, computer and
      other control systems. We may have difficulty in hiring and retaining a
      sufficient number of qualified employees to work in the PRC. As a result of
      these factors, we may experience difficulty in establishing management, legal
      and financial controls, collecting financial data and preparing financial
      statements, books of account and corporate records and instituting business
      practices that meet Western standards.





**It
      will be extremely difficult to acquire jurisdiction and enforce liabilities
      against our officers, directors and assets based in the
      PRC.**





Because
      our executive officers and several of our directors, including our chairman
      of
      the Board of Directors, are Chinese citizens, it may be difficult, if not
      impossible, to acquire jurisdiction over these persons in the event a lawsuit
      is
      initiated against us and/or our officers and directors by a stockholder or
      group
      of stockholders in the United States. Also, because the majority of our assets
      are located in the PRC, it would also be extremely difficult to access those
      assets to satisfy an award entered against us in U.S. court.


-
          35 -




**The
      legal system in China has inherent uncertainties that may limit the legal
      protections available in the event of any claims or disputes with third
      parties.**





The
      legal
      system in China is based on written statutes. Prior court decisions may be
      cited
      for reference but have limited precedential value. Since 1979, the central
      government has promulgated laws and regulations dealing with economic matters
      such as foreign investment, corporate organization and governance, commerce,
      taxation and trade. As China’s foreign investment laws and regulations are
      relatively new and the legal system is still evolving, the interpretation of
      many laws, regulations and rules is not always uniform and enforcement of these
      laws, regulations and rules involve uncertainties, which may limit the remedies
      available in the event of any claims or disputes with third parties. In
      addition, any litigation in





China
      may
      be protracted and result in substantial costs and diversion of resources and
      management attention.





**We
      may face political and/or judicial corruption in the PRC.**




Another
      obstacle to foreign investment is corruption. There is no assurance that we
      will
      be able to obtain recourse, if desired, through the PRC’s poorly developed and
      often corrupt judicial systems.




Most
      of
      our assets are located in China, any dividends of proceeds from liquidation
      is
      subject to the approval of the relevant Chinese government
      agencies.





**Item
      2.**  **Management’s
      Discussion and Analysis or Plan of Operation**





**INFORMATION
      REGARDING FORWARD LOOKING STATEMENTS**





The
      following discussion should be read in conjunction with the unaudited condensed
      consolidated financial statements and notes thereto set forth in Item 1 of
      this
      Quarterly Report. In addition to historical information, this discussion and
      analysis contains forward-looking statements that relate to future events and
      expectations and, as such, constitute forward-looking statements.
      Forward-looking statements include those containing such words as” anticipates,”
“believes,” “estimates,” “expects,” “hopes,” “targets,” “should,” will,” “will
      likely result,” “forecast,” “outlook,” “projects” or similar expressions. Such
      forward-looking statements involve known and unknown risks, uncertainties and
      other factors that may cause actual results, performance or achievements of
      the
      Company to be materially different from those expressed or implied in the
      forward-looking statements.





**OVERVIEW**




We
      were
      incorporated under the laws of the state of Nevada and, along with our
      wholly-owned subsidiaries, are headquartered in Harbin, China. We manufacture,
      design, supply and service linear motors and special motors for domestic China
      and other international markets. Our products are purchased by a broad range
      of
      customers, including those involved in oil services, factory automation,
      packaging and mass transportation systems.




Our
      expenses have consisted primarily of those incurred with sales and marketing
      of
      our products, general and administrative costs associated with our operations
      and costs of maintaining our facilities, salaries and research and development.
      To date, we have funded our operations primarily through the sale of equity
      securities and retained earnings.




We
      are
      subject to risks common to companies operating in China, including risks
      inherent in our distribution and commercialization efforts, uncertainty of
      foreign regulatory and marketing approvals and laws, reliance on key customers,
      enforcement of patent and proprietary rights, the need for future capital and
      retention of key employees. We cannot provide assurance that we will generate
      revenues or achieve and sustain profitability in the future.


-
          36 -





**ACCOUNTING
      POLICIES AND ESTIMATES**





We
      believe that the application of the following accounting policies, which are
      important to our financial position and results of operations, requires
      significant judgments and estimates on the part of management. For a summary
      of
      our significant accounting policies, see Note 2 of the consolidated
      financial statements appearing elsewhere in this Quarterly Report.





***Accounts
      Receivable***





We
      maintain reserves for potential credit losses on accounts receivable. Management
      reviews the composition of accounts receivable and analyze historical bad debts,
      customer concentrations, customer credit worthiness, current economic trends
      and
      changes in customer payment patterns to evaluate the adequacy of these
      reserves.





We
      use
      estimates in determining our allowance for bad debts that are based on our
      historical collection experience, current trends, credit policy and a percentage
      of our accounts receivable by aging category. In determining these percentages,
      we review historical write-offs in our receivables. In determining the
      appropriate reserve percentages, we also review current trends in the credit
      quality of our customers, as well as changes in our internal credit policies.
      We
      maintain reserves for potential credit losses on accounts receivable. Management
      reviews the composition of accounts receivable and analyzes historical bad
      debts, customer concentrations, customer credit worthiness, current economic
      trends and changes in customer payment patterns to evaluate the adequacy of
      these reserves. Reserves are recorded primarily on a specific identification
      basis. Additional allowances for doubtful accounts may be required if there
      is
      deterioration in past due balances, if economic conditions are less favorable
      than anticipated, or for customer-specific circumstances, such as financial
      difficulty.





Reserves
      are recorded primarily on a specific identification basis. Reserve for potential
      credit losses was $44,552 as of December 31, 2006 and $46,359 as of September
      30, 2007. No amounts were written off during the periods indicated. If our
      estimate of our allowance is understated in future periods, operating income
      would be reduced.





***Inventories***




Inventory
      levels are based on projections of future demand and market conditions.
      Inventories are stated at cost, which is not in excess of market using the
      weighted average cost method. Any sudden decline in demand and/or rapid product
      improvements and technological changes can result in excess and/or obsolete
      inventories. Because most of our products are customized and unique to a
      particular customer, there is a risk that we will forecast inventory needs
      incorrectly and purchase or produce excess inventory. As a result, actual demand
      may differ from forecasts, and such differences, if not managed, may have a
      material adverse effect on future results of operations due to required
      write-offs of excess or obsolete inventory. To mitigate against such exposure,
      we require a binding purchase order or a signed agreement by our customer
      agreeing to pay for and take possession of finished goods inventory parts for
      the duration of the agreement.




On
      an
      ongoing basis, inventories are reviewed for potential write down for estimated
      obsolescence or unmarketable inventories equal to the difference between the
      costs of inventories and the estimated net realizable value based upon forecasts
      for future demand and market conditions. We have experienced no inventory write
      downs since our inception. Accordingly, we have not created any reserve for
      obsolete inventory consistent with our historical experience. To the extent
      we
      increase our reserves for future periods, operating income will be
      reduced.


-
          37 -





***Revenue
      Recognition***




Our
      revenue recognition policies are structured to comply with Staff Accounting
      Bulletin (SAB) 104 and SFAS 48. SAB 104 requires that revenue can only be
      recognized when it is realized or realizable and earned. Revenue generally
      is
      realized or realizable and earned when all four of the following criteria have
      been met: (1) persuasive evidence of an arrangement exists; (2) delivery has
      occurred or services rendered; (3) the price is fixed and determinable; and
      (4)
      collectability is reasonably assured.




Determination
      of criterion (4) is based on our judgments regarding the collectability of
      those
      amounts. Historically, we have not encountered any significant problems with
      collectability and thus have determined that it is not necessary to defer
      revenue recognition on that basis. Should changes in conditions cause us to
      determine this criterion is not met for certain future transactions, revenues
      for any reporting period could be adversely affected by delaying recognition
      of
      such revenues.




In
      addition, our revenue recognition could be negatively impacted by returns.
      However, we make custom products which are customer specific, and no returns
      are
      allowed. We warrant our product for repair only in the event of defects for
      two
      years from the date of shipment. Historically, we have not experienced
      significant defects, and replacements for defects have not been material. We
      charge such costs to cost of goods sold. For the year ended December 31, 2006
      and for the nine months ended September 30, 2007, such returns and allowances
      were $0 for each of the periods. Should returns increase in the future it would
      be necessary to adjust our estimates, in which case recognition of revenues
      could be delayed.




***Stock-Based
      Compensation***




The
      Company accounts for stock-based compensation in accordance with the fair value
      recognition provisions of SFAS 123R. The Company uses the Black-Scholes-Merton
      option-pricing model which requires the input of highly subjective assumptions.
      These assumptions include estimating the length of time employees will retain
      their stock options before exercising them (“expected term”), the estimated
      volatility of the Company’s common stock price over the expected term and the
      number of options that will ultimately not complete their vesting requirements
      (“forfeitures”). Changes in the subjective assumptions can materially affect the
      estimate of fair value of stock-based compensation and consequently, the related
      amount recognized on the consolidated statements of earnings.





***Derivative
      Financial Instruments***





The
      Company uses derivative financial instrument such as cross-currency swap.
      Derivative financial instrument is initially recognized in the balance sheet
      at
      cost and subsequently re-measured at the fair value. Changes in the fair values
      of derivative financial instruments accounted for as cash flow hedges, to the
      extent they qualify for hedge accounting, are recorded in accumulated other
      comprehensive income, net of deferred taxes, changes in fair values of
      derivative financial instruments not qualifying as hedges are reported in
      income.





At
      the
      inception of the transaction, the Company documents the relationship between
      hedging instruments and hedged items, as well as its risk management objective
      and the strategy for undertaking various hedge transactions. This process
      includes linking all derivatives designated to specific firm commitments of
      forecast transactions. The Company also documents its assessment, both at
      inception and on an ongoing basis, of whether the derivative financial
      instruments that are used in hedging transactions are highly effective in
      offsetting changes in fair values or cash flows of hedged
      items.


-
          38 -





***Change
      in Accounting Principle***





On
      January 1, 2007, the Company adopted FASB Staff Position No. EITF 00-19-2,
      “Accounting for Registration Payment Arrangements” (“FSP EITF 00-19-2”). FSP
      EITF 00-19-2 requires contingent obligations under a registration payment
      arrangement to be recognized and measured in accordance with SFAS No. 5,
“Accounting for Contingencies” (“FAS 5”). FAS 5 requires loss contingencies to
      be accrued and expensed if they are probable and reasonably
      estimable.





Upon
      adoption of FSP EITF 00-19-2, any warrants originally classified as a liability
      under EITF 00-19 that would have been classified as equity without regard to
      the
      registration payment arrangement should be reclassified. The transition to
      the
      accounting treatment under FSP EITF 00-19-2 is shown in the accompanying
      financial statements through 1) a cumulative-effect adjustment to the opening
      balance of retained earnings, as of January 1, 2007 and 2) reclassifying the
      warrants to equity at their fair value on the date of grant.





The
      adjustment totaled $6,353,033 and was equal to the change in fair value of
      the
      warrants between October 6, 2006, the date the warrants were issued, and
      December 31, 2006, the last reporting period. Additionally, the warrants were
      reclassified as equity at $22,921,113, their fair value on October 6, 2006.
      The
      adoption of FSP EITF 00-19-2 did not have an impact on prior year financial
      statements.




**RESULTS
      OF OPERATIONS**





NINE
      MONTHS ENDED SEPTEMBER 30, 2007 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
      2006





***Revenue***





For
      the
      nine months ended September 30, 2007, we generated net revenues of $46,115,945
      compared to $28,407,056 during the nine-month ended September 30, 2006. Sales
      of
      linear motor and special motor products drove the growth in the period.
      Industrial electric linear motors and special motors continued to comprise
      significantly all of our total product sales in both comparable periods. The
      increase was due to increased sales to our existing customers and also our
      new
      customers that we obtained through the acquisition of Harbin Taifu Auto Electric
      Co., Ltd. The total revenue contributed from the acquisition was approximately
      $5.17 million.





***Gross
      Profit***





The
      Company achieved a gross profit of $23,139,989 for the nine months ended
      September 30, 2007 compared to $13,879,024 for the nine months ended September
      30, 2006. The increase is directly related to our increases in sales levels
      and
      improved mix of product sales. Gross margin, as a percentage of revenues, was
      50.2% for the nine months ended September 30, 2007 compared to 48.9% for the
      nine months ended September 30, 2006. The gross margin percentage remains within
      a normal range and the change reflects a more favorable mix of products shipped
      in the first and second quarters of 2007 versus the corresponding period in
      2006.





***Operating
      Expenses***





Our
      total
      operating expenses consist of costs associated with sales and marketing,
      research and development, general and administrative costs, and non-cash amounts
      to account for stock based compensation. The Company incurred total operating
      expenses of $5,413,058, or 11.7% of sales, for the nine months ended September
      30, 2007. This represents an increase of $1,123,611 compared to $4,289,447,
      or
      15.1% of sales for the nine months ended September 30, 2006. Selling, general
      and administrative expense amounted $4,661,175, or 10.1% of sales, compared
      to
      $3,065,619 or 10.8% for the nine months ended September 30, 2006. SG&A
      accounts for expenses associated with sales, marketing of the Company’s
      products, costs of maintaining the Company’s facilities, salaries, as well as
      amounts allocated to stock based compensation through options grants. The
      increase this period is due to our efforts to support an increased revenues
      level and related sales activity and stock based compensation
      expense.


-
          39 -





***Interest
      expense***





Net
      interest expense (income) for the nine months ended September 30, 2007 and
      2006,
      were $5,713,372 and $(57,602), respectively. Net interest expense for nine
      months ended September 30, 2007 was comprised of the amortization of debt
      issuance costs, the amortization of debt discount, accrued interest expense
      for
      the semiannual interest due in August on our $50 million debt, and offset by
      interest income earned on cash deposits and interest rate swap agreement with
      Merrill Lynch signed on April 2, 2007.





Amortization
      expense of debt discount amounted to $3,399,099 during the nine months ended
      September 30, 2007 compared to $0 for the nine months ended September 30, 2006.
      The increase for the period was attributable to amortization of debt discount
      for the $50 million notes issued on August 30, 2006. As of September 30, 2007,
      the unamortized debt discount totaled $18,011,302.





Debt
      issuance costs totaled $2,954,625 are carried in other assets and are amortized
      over the life of the loan using the effective interest method. $554,551 was
      amortized to interest expense for the nine months ended September 30, 2007.
      As
      of September 30, 2007, the unamortized debt issuance costs totaled
      $2,183,661.





As
      of
      September 30, 2007, the Company received $554,602 from Merrill Lynch on behalf
      of the cross currency hedge, which was recorded as a gain from derivative
      transactions.





***Non-operating
      income***





The
      Chinese government grants to all new technology and innovated manufacturers
      financial grant income. The income received from the government was recorded
      as
      additional paid in capital. The Company has received a total of $774,482 and
      $0
      for the nine months ended September 30, 2007 and 2006, respectively. The grant
      income can be continuous and under the Chinese government restriction, the
      Company cannot forecast or control the amount to be received.





***Net
      Income***





The
      Company's net income was $ 12,724,441 or 27.6% of sales for the nine months
      ended September 30, 2007, compared to $11,755,399 or 41.4% of sales for the
      nine
      months ended September 30, 2006. Increase
      in net income was due to the new customers, new product lines, and incresed
      sales to the existing customer, especially the sales from new acquired Harbin
      Taifu Auto Electric Co.





THREE
      MONTHS ENDED SEPTEMBER 30, 2007 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30,
      2006





***Revenue***





For
      the
      three months ended September 30, 2007, we generated net revenues of $18,500,038
      compared to $9,817,053 for the three months ended September 30, 2006. Sales
      of
      linear motor and special motor products drove the growth in the period.
      Industrial electric linear motors and special motors continued to comprise
      significantly all of our total product sales in both comparable periods.


-
          40 -





***Gross
      Profit***





The
      Company achieved a gross profit of $9,061,691 for the three months ended
      September 30, 2007 compared to $4,804,497 for the nine months ended September
      30, 2006. The increase is directly related to our increases in sales levels
      and
      improved mix of product sales. Gross margin, as a percentage of revenues, was
      49.0% for the three months ended September 30, 2007 compared to 48.9% for the
      three months ended September 30, 2006. The gross margin remains within a normal
      range and the change reflects a more favorable mix of products shipped in the
      third quarter of 2007 versus the corresponding period in 2006.





***Operating
      Expenses***





Our
      total
      operating expenses consist of costs associated with sales and marketing,
      research and development expenditures, general administrative costs, and amounts
      to account for stock based compensation. The Company incurred total operating
      expenses of $1,999,378, or 10.8% of sales for the three months ended September
      30, 2007. This represents a reduction of $32,462 compared to $2,031,840, or
      20.7% of sales for the three months ended September 30, 2006. Aggregated selling
      general and administrative expenses of $1,700,854, or 9.2% of sales, compared
      to
      $1,634,766 or 16.7% for the three months ended September 30, 2006. SG&A
      accounts for expenses associated with sales, marketing of the Company’s
      products, costs of maintaining the Company’s facilities, salaries, as well as
      amounts allocated to stock based compensation through options grants.





***Net
      Income***





The
      Company's net income was $ 4,764,222 or 25.8% of sales for the three months
      ended September 30, 2007, an increase of $481,066 or 11.2% compared to
      $4,283,156 or 43.6% of sales for the three months ended September 30, 2006.
      Increase in income was due to the increase of the company's main operation
      sales, increase in government grants,  and
      also
      the interest income due to the cash deposit in bank and the cross currency
      swap
      interest income.





**Liquidity
      and Capital Resources**




As
      of
      September 30, 2007, the Company had $61,060,638 cash and cash equivalents.
      The
      Company had net cash flows provided by operations of $15,050,037 for the nine
      month period ended September 30, 2007, as compared to net cash provided by
      operations of $6,113,114 in the corresponding period last year. The change
      in
      net cash flows from operations in the current period as compared to the
      corresponding period last year was mainly from the working capital. Cash flows
      used in investing activities was $21,649,411 for the nine months ended September
      30, 2007 compared with a net cash provided by investing activities for the
      amount of $559,052 for the same period ended September 30, 2006. The increase
      investing activity was due to prepayments related to new equipment purchases
      and
      investments in fixed assets. The change in net cash flows used in financing
      activity was $1,903,250 for the nine months ended September 30, 2007 as a result
      of deposit to secure derivative instrument. Compare to cash provided by
      financing activity of $47,779,559 in the same period in 2006, in which period
      the Company received total capital contribution amounted to $47,462,700. The
      Company had a net decrease in cash and cash equivalent of $6,253,281 in the
      current period as compared to a net increase of $54,854,750 in the corresponding
      period last year. Our net decrease in cash and cash equivalents during the
      nine
      months ended September 30, 2007 was mainly due to prepayments made for equipment
      purchases and deposit to secure derivative instruments.





On
      August
      29, 2006, the Company, AEM, Citadel and Merrill Lynch entered into the Purchase
      Agreement relating to the purchase and sale of (a) $50.0 million aggregate
      principal amount of the Company's Notes and (b) fully detachable Warrants to
      purchase an aggregate of 3,487,368 shares of our common stock. The transaction
      closed on August 30, 2006.


-
          41 -


The
      notes
      are governed by an indenture, dated August 30, 2006 (the “Indenture”), entered
      into among the Company, AEM, as guarantor, and The Bank of New York, as trustee
      for the Notes. Of the $50 million aggregate principal amount of the Notes,
      Citadel subscribed to $38 million of the principal amount of the 2012 Notes,
      which mature on September 1, 2012, and Merrill Lynch subscribed to $12 million
      of the principal amount of the 2010 Notes, which mature on September 1, 2010.
      Pursuant to the indenture, AEM has agreed, and all of our other existing and
      future subsidiaries (other than subsidiaries domiciled in the People's Republic
      of China) are obligated, to guarantee, on a senior secured basis, to the
      Investors and to the trustee the payment and performance of our
      obligations.





As
      security for the Notes, we and The Bank of New York, as collateral agent,
      entered into a share pledge agreement, dated August 30, 2006, to secure the
      Notes with all of the shares of AEM common stock held by us.





The
      Warrants are governed by a warrant agreement, dated August 30, 2006, between
      us
      and The Bank of New York, as warrant agent. The Warrants consist of (i) the
      First Tranche 2012 Warrants which permit the purchase of an aggregate of
      2,192,308 shares of our common stock, at an exercise price of $7.80 per share,
      (ii) the Second Tranche 2012 Warrants which permit the purchase of an aggregate
      of 525,830 shares of our common stock at an exercise price of $10.84 per share
      and (iii) the 2009 Warrants which permit the purchase of an aggregate of 769,230
      shares of our common stock at an exercise price of $7.80 per share. The First
      Tranche 2012 Warrants and the Second Tranche 2012 Warrants were issued to
      Citadel, and the 2009 Warrants were issued to Merrill. Each Warrant is
      exercisable at the option of the Warrant holder at any time through the maturity
      date of such Warrant. All of the Warrants contain a cashless exercise feature.
      To the extent Warrants are exercised for cash, however, the Company would
      receive the payment of the exercise price.




On
      August
      25, 2006 the Company’s subsidiary HTFE signed an R&D Agreement with IEECAS.
      Under the R&D Agreement with IEECAS, HTFE is obligated to invest
      approximately $1.88 million (of which approximately $1.25 million previously
      has
      been paid) during the period ending in early 2009. On September 8, 2006 the
      Company’s subsidiary HTFE signed a Land Use Agreement for a plot of land in
      Shanghai. HTFE is obligated to make an additional Fee payment of approximately
      $1.27 million (the timing of which is dependent upon completion of certain
      regulatory applications and receipt of a regulatory permit for work
      commencement) as well as to invest approximately $15 million in Site
      investments. It is anticipated that, as permitted by the Indenture, the Company
      will use a portion of the proceeds from placement of the Notes to Merrill Lynch
      and Citadel for such purposes. In addition, interest on the Notes is payable
      semi-annually in arrears, commencing March 1, 2007. The Company anticipates
      that
      existing cash reserves and cash flow from future operations will be used for
      such purposes.





***Cross
      currency hedge***





The
      Company's operations are exposed to a variety of global market risks, including
      the effect of changes in foreign currency exchange rates and interest rates.
      These exposures are managed, in part, with the use of financial derivatives.
      The
      Company uses financial derivatives only to hedge exposures in the ordinary
      course of business and dose not invest in derivative instruments for speculative
      purposes.





Effective
      April 17, 2007, the Company entered into a cross currency swap agreement with
      Merrill Lynch exchanging the LIBOR plus 4.75% variable rate interest payable
      on
      the $38 million Merrill Lynch debt for 7.2% (3.6% semi-annually) fixed rate
      interest. The agreement requires semi-annual payments on March 1 and September
      1
      through the maturity of the agreement on September 1, 2012. Merrill Lynch
      required the Company to deposit $1,000,000 with them to secure the agreement.
      The deposit may be increased to $2,500,000 if the exchange rate for Renminbi
      to
      USD falls below 6.5, and to $4,000,000 if the exchange rate falls below 5.5.
      This swap is designated and qualified as a cash flow hedge.


-
          42 -





The
      fair
      value of this swap agreement at April 02, 2007 (inception date) was a payable
      of
      $5,387,487, and at September 30, 2007 was a payable of $7,047,406. From the
      inception date to September 30, 2007, changes in fair value of the swap resulted
      in other comprehensive loss of $1,659,919, net of taxes and an
      increase to liability. During the nine months ended September 30, 2007, the
      Company received $554,602, which was recorded as a gain from derivative
      transactions. For nine months ended September 30, 2007, there were no amounts
      recorded in the consolidated statement of income in relation to this interest
      rate swap related to ineffectiveness of derivative instrument.





The
      Company accounts for this interest rate swap in accordance with FAS No. 133,
      “Accounting for Derivatives Instruments and Hedging Activity,” which requires
      all derivatives to be carried on the balance sheet at fair value and to meet
      certain documentary and analytical requirements to qualify for hedge accounting
      treatment. The above derivative qualifies for hedge accounting under FAS 133
      and, accordingly, changes in the fair value is reported in accumulated other
      comprehensive income, net of related income tax effects.





**Item
      3. Controls and Procedures**




(a) **Evaluation
      of Disclosure Controls and Procedures.**




The
      Company’s Chief Executive Officer and Chief Financial Officer conducted an
      evaluation of the effectiveness of the design and operation of the Company’s
      disclosure controls and procedures as defined in Securities Exchange Act of
      1934
      Rule 13a-15(e), as of the end of the period covered by this report. Based on
      that evaluation, the Chief Executive Officer and Chief Financial Officer
      concluded that the Company’s disclosure controls and procedures were effective
      as of the end of the period covered by this report.




**(b)**  **Changes
      in Internal Control over Financial Reporting.**





There
      were no changes in internal controls over financial reporting that occurred
      during the third quarter of 2007 that have materially affected, or are
      reasonably likely to materially affect, the Company’s internal control over
      financial reporting.





We
      will
      be subject to reporting obligations under the U.S. securities laws. The
      Securities and Exchange Commission (“SEC”), as required by Section 404 of
      the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act”), adopted rules requiring
      every public company to include a management report on such company’s internal
      controls over financial reporting in its annual report, which contains
      management’s assessment of the effectiveness of the company’s internal controls
      over financial reporting. In addition, an independent registered public
      accounting firm must attest to and report on management’s assessment of the
      effectiveness of the company’s internal controls over financial reporting. These
      requirements will first apply to our annual report on Form 10-K for the fiscal
      year ending December 31, 2007. Our management may conclude that our
      internal controls over our financial reporting are not effective. Moreover,
      even
      if our management concludes that our internal controls over financial reporting
      are effective, our independent registered public accounting firm may still
      decline to attest to our management’s assessment or may issue a report that is
      qualified if it is not satisfied with our controls or the level at which our
      controls are documented, designed, operated, or reviewed, or if it interprets
      the relevant requirements differently from us. Our reporting obligations as
      a
      public company will place a significant strain on our management, operational,
      and financial resources and systems for the foreseeable future. Effective
      internal controls, particularly those related to revenue recognition, are
      necessary for us to produce reliable financial reports and are important to
      help
      prevent fraud. As a result, our failure to achieve and maintain effective
      internal controls over financial reporting could result in the loss of investor
      confidence in the reliability of our financial statements, which in turn could
      harm our business and negatively impact the trading price of our stock.
      Furthermore, we anticipate that we will incur considerable costs and use
      significant management time and other resources in an effort to comply with
      Section 404 and other requirements of the Sarbanes-Oxley
      Act.


-
          43 -





**PART
      II. OTHER INFORMATION**




**Item
      1.**  **Legal
      Proceedings**




From
      time
      to time, the Company becomes involved in various lawsuits and legal proceedings
      which arise in the ordinary course of business.




Following
      is the summary of the current litigation as of September 30,
      2007.




Leong
      Sing Lye v. Harbin Electric, Inc. United States District Court, District of
      Nevada, Case No. 2:06-CV-00796





In
      June
      2006, an action was filed against the Company by Leong Sing Lye in the United
      States District Court for the District of Nevada, seeking specific performance
      of the Company's alleged obligation to issue 228,000 shares of Common Stock
      and
      warrants to purchase 38,400 shares of common stock, or , in the alternative,
      the
      value of securities alleged to be owed to Mr. Lye under, or, monetary damages
      allegedly arising from, a so-called Appointment Agreement pursuant to which
      Mr.
      Lye alleges to have been appointed the Company's Consultant of Corporate
      Strategy, as well as court costs and reasonable attorneys' fees. The Company
      has
      filed an answer to Mr. Lye's complaint denying the material allegations thereof
      and a counterclaim against Mr. Lye for fraud and related claims. The Company
      intends to vigorously defend against Mr. Lye's claim, if not withdrawn, and
      pursue its counterclaim. The parties are in the discovery process. The Company
      has filed a motion for summary judgment to eliminate portions of Mr. Lye's
      case
      and Mr. Lye has filed a cross-motion. The parties await the Court's ruling
      on
      these matters. The Company does not believe that the ultimate outcome of this
      matter will have a material adverse effect on the Company.





**Item
      2.**  **Unregistered
      Sales of Equity Securities and Use of Proceeds**





None.




**Item
      3.**  **Defaults
      upon Senior Securities**




None.





**Item
      4.**  **Submission
      of Matters to a Vote of Securities Holders**




None.





**Item
      5.**  **Other
      Information**


On
      October 23, 2007, the Company entered into an
      Equity
      Registration Rights Agreement with Abax
      Lotus Ltd., a Cayman Islands limited company (the “Abax Lotus”), Hero Wave
      Investments Limited, a British Virgin Islands company (“Hero Wave”) and Tianfu
      Yang, as guarantor, pursuant to which the
      Company has agreed to provide registration rights with respect to (i) an
      aggregate of 700,000 shares of common stock of the Company sold by Hero Wave,
      Broad Globe Investments Limited, a British Virgin Islands limited company
      (“Broad Globe”), Victory Lake Investments Limited, a British Virgin Islands
      limited company (“Victory Lake”), and Sea Giant Investments Limited, a British
      Virgin Islands limited company (“Sea Giant”), to Abax Lotus and (ii) certain
      additional shares of common stock of the Company which may be subsequently
      acquired by Abax Lotus on or prior to March 1, 2009. Tianfu Yang, the Company’s
      Chief Executive Officer, is the owner of 100% of the outstanding equity of
      Hero
      Wave, Suofei Xu, the Company’s Vice President, is the owner of 100% of the
      outstanding equity of Broad Globe, Zedong Xu, the Company’s Chief Financial
      Officer, is the owner of 100% of the outstanding equity of Victory Lake, and
      Tianli Yang, the Company’s Vice President, is the owner of 100% of outstanding
      equity of Sea Giant.


-
          44 -


Pursuant
      to the terms of the Equity Registration Rights Agreement, (i) the Company has
      agreed to prepare and file with the Securities and Exchange Commission (the
      “SEC”), within sixty (60) days after October 17, 2007 a Registration Statement
      for an offering to be made on a delayed or continuous basis pursuant to Rule
      415
      of the Securities Act (a “Shelf Registration Statement”) registering the resale
      from time to time of all Registrable Securities (as defined in the Agreement)
      by
      any person(s) who hold Registrable Securities (collectively, the “Holders”) and
      (ii) the Company has agreed to use its best efforts to cause the initial Shelf
      Registration Statement to become effective under the Securities Act as promptly
      as is practicable but in any event by the date that is one hundred twenty (120)
      days after October 17, 2007.





Pursuant
      to the terms of the Equity Registration Rights Agreement, at any time and from
      time to time beginning on or after March 1, 2008 and ending on March 1, 2009
      any
      of the Holders shall be entitled to make up to two written demands for
      registration (each a “Demand”). under the Securities Act of any Registrable
      Securities then held by such Holder(s), other than Registrable Securities
      acquired under the Purchase Agreement dated as of September 28, 2007, by and
      between Abax Lotus and Hero Wave, the Purchase Agreement dated as of September
      28, 2007, by and between Abax Lotus and Broad Globe, the Purchase Agreement
      dated as of September 28, 2007, by and between Abax Lotus and Victory Lake,
      and
      the Purchase Agreement dated as of September 28, 2007, by and between Abax
      Lotus
      and Sea Giant. Upon receipt of such Demand, the Company has agreed to prepare
      and file or cause to be prepared and filed with the SEC, a Registration
      Statement with respect to the Registrable Securities the subject of the Demand
      and use its best efforts to cause such Registration Statement to become
      effective under the Securities Act as promptly as is practicable but in any
      event by the date that is one hundred and twenty (120) days after the Company
      receives the Demand.





**I** **tem
      6.**  **Exhibits.**




**Exhibit
                  Number**
              
              **Description**
              
              **Method
                  of Filing**3.1
              
              Articles
                  of Incorporation of the Company
              
              Filed
                  as Exhibit 3.1 to the registration statement on Form SB-2 filed
                  with the
                  Commission on October 10, 2003 and incorporated herein by
                  reference.3.2
              
              Amended
                  and Restated Bylaws of the Company
              
              Filed
                  as Exhibit 10.1 to the current report on Form 8-K filed with the
                  Commission on July 6, 2005 and incorporated herein by
                  reference.3.3
              
              Amendment
                  to the Bylaws of the Company
              
              Filed
                  as Exhibit 4.1 to the current report on Form 8-K filed with the
                  Commission on December 20, 2006 and incorporated herein by
                  reference.10.1
              
              Registration
                  Rights Agreement dated as of August 31, 2005
              
              Filed
                  as Exhibit 10.1 to the registration statement on Form SB-2 filed
                  with the
                  Commission on April 27, 2006 and incorporated herein by
                  reference.10.2
              
              Common
                  Stock Purchase Agreement dated as of August 31, 2005
              
              Filed
                  as Exhibit 10.2 to the registration statement on Form SB-2 filed
                  with the
                  Commission on April 27, 2006 and incorporated herein by
                  reference.10.3
              
              Option
                  Agreement dated as of August 31, 2005
              
              Filed
                  as Exhibit 10.3 to the registration statement on Form SB-2 filed
                  with the
                  Commission on April 27, 2006 and incorporated herein by
                  reference.
  -
            45 -






10.4
              
              Employment
                  Agreement, dated October 12, 2005, between the Company and Mr.
                  Barry
                  Raeburn
              
              Filed
                  as Exhibit 10.1 to the current report on Form 8-K filed with the
                  Commission on October 17, 2005 and incorporated herein by
                  reference.10.5
              
              Term
                  Sheet dated August 2, 2006
              
              Filed
                  as Exhibit 10.5 to the current report on Form 8-K filed with the
                  Commission on August 2, 2006 and incorporated herein by
                  reference.10.6
              
              Agreement
                  on Cooperation between Harbin Tech Full Electric Co., Ltd. and
                  Institute
                  of Electrical Engineering of the Chinese Academy of
                  Sciences
              
              Filed
                  as Exhibit 10.6 to the current report on Form 8-K filed with the
                  Commission on August 25, 2006 and incorporated herein by
                  reference.10.7
              
              Purchase
                  Agreement among the Company, Advanced Electric Motors, Inc., Citadel
                  Equity Fund Ltd. and Merrill Lynch International, dated August
                  29,
                  2006
              
              Filed
                  as Exhibit 4.1 to the current report on Form 8-K filed with the
                  Commission
                  on September 1, 2006 and incorporated herein by
                  reference.10.8
              
              Indenture
                  among the Company, Advanced Electric Motors, Inc. and The Bank
                  of New
                  York, as trustee, dated August 30, 2006
              
              Filed
                  as Exhibit 4.2 to the current report on Form 8-K filed with the
                  Commission
                  on September 1, 2006 and incorporated herein by
                  reference.10.9(a)
              
              2010
                  Global Note
              
              Filed
                  as Exhibit 4.3(a) to the current report on Form 8-K filed with
                  the
                  Commission on September 1, 2006 and incorporated herein by
                  reference.10.9(b)
              
              2012
                  Global Note
              
              Filed
                  as Exhibit 4.3(b) to the current report on Form 8-K filed with
                  the
                  Commission on September 1, 2006 and incorporated herein by
                  reference.10.10
              
              Registration
                  Rights Agreement between the Company and the Investors, dated August
                  30,
                  2006
              
              Filed
                  as Exhibit 4.4 to the current report on Form 8-K filed with the
                  Commission
                  on September 1, 2006 and incorporated herein by
                  reference.10.11
              
              Share
                  Pledge Agreement between the Company and The Bank of New York,
                  as
                  collateral agent, dated August 30, 2006
              
              Filed
                  as Exhibit 4.5 to the current report on Form 8-K filed with the
                  Commission
                  on September 1, 2006 and incorporated herein by
                  reference.10.12
              
              Warrant
                  Agreement between the Company and The Bank of New York, as warrant
                  agent,
                  dated August 30, 2006
              
              Filed
                  as Exhibit 4.6 to the current report on Form 8-K filed with the
                  Commission
                  on September 1, 2006 and incorporated herein by
                  reference.10.13(a)
              
              Global
                  First Tranche 2012 Warrants
              
              Filed
                  as Exhibit 4.7(a) to the current report on Form 8-K filed with
                  the
                  Commission on September 1, 2006 and incorporated herein by
                  reference.





-
          46 -


10.13(b)
              
              Global
                  Second Tranche 2012 Warrants
              
              Filed
                  as Exhibit 4.7(b) to the current report on Form 8-K filed with
                  the
                  Commission on September 1, 2006 and incorporated herein by
                  reference.10.13(c)
              
              Global
                  2009 Warrants
              
              Filed
                  as Exhibit 4.7(c) to the current report on Form 8-K filed with
                  the
                  Commission on September 1, 2006 and incorporated herein by
                  reference.10.14
              
              Voting
                  Agreement among the Company, Tianfu Yang and Citadel Equity Fund
                  Ltd.,
                  dated August 30, 2006
              
              Filed
                  as Exhibit 4.8 to the current report on Form 8-K filed with the
                  Commission
                  on September 1, 2001 and incorporated herein by
                  reference.10.15
              
              Noncompetition
                  Covenant and Agreement among Citadel Equity Fund Ltd., Merrill
                  Lynch
                  International and Tianfu Yang, dated August 30, 2006
              
              Filed
                  as Exhibit 10.15 to the Registration Statement on SB-2 filed with
                  the
                  Commission on October 4, 2006 and incorporated herein by
                  reference.10.16
              
              Agreement
                  between Harbin Tech Full Electric Co., Ltd. and Shanghai Lingang
                  Investment and Development Company Limited, dated September 8,
                  2006
              
              Filed
                  as Exhibit 10.15 to the Registration Statement on SB-2 filed with
                  the
                  Commission on October 4, 2006 and incorporated herein by
                  reference.10.17
              
              Letter
                  Agreement dated April 9, 2007 by and among Harbin Electric, Inc,
                  Shelton
                  Technology LLC, Shaotang Chen and Xioagang Luo
              
              Filed
                  as Exhibit 10.1 to the current report on Form 8-K filed with the
                  Commission on April 13, 2007 and incorporated herein by
                  reference.10.18
              
              License
                  Agreement dated as of April 9, 2007 by and among Advanced Automation
                  Group. LLC, Shelton Technology, LLC, Shaotang Chen and Xiaogang
                  Luo
              
              Filed
                  as Exhibit 10.2 to the current report on Form 8-K filed with the
                  Commission on April 13, 2007 and incorporated herein by
                  reference.10.19
              
              Employment
                  Agreement dated April 9, 2007 by and between Advanced Automation
                  Group,
                  LLC and Shaotang Chen
              
              Filed
                  as Exhibit 10.3 to the current report on Form 8-K filed with the
                  Commission on April 13, 2007 and incorporated herein by
                  reference.10.20
              
              Employment
                  Agreement dated April 9, 2007 by and between Advanced Automation
                  Group,
                  LLC and Xiaogang Luo.
              
              Filed
                  as Exhibit 10.4 to the current report on Form 8-K filed with the
                  Commission on April 13, 2007 and incorporated herein by
                  reference.14.1
              
              Code
                  of Ethics and Business Conduct
              
              Previously
                  filed.21.1
              
              List
                  of subsidiaries
              
              Filed
                  as Exhibit 21.1 to the quarterly report on Form 10-QSB filed with
                  the
                  Commission on May 15, 2006 and incorporated herein by
                  reference.





-
          47 -





31.1
            
            Certification
                by the Chief Executive Officer pursuant to Rule 13a-14(a) or
                15d-14(a)
            
            Filed
                herewith as Exhibit 31.1.31.2
            
            Certification
                by the Chief Financial Officer pursuant to Rule 13a-14(a) or
                15d-14(a)
            
            Filed
                herewith as Exhibit 31.2.32.1
            
            Certification
                of the Chief Executive Officer and the Chief Financial Officer pursuant
                18
                U.S.C. Section 1350, as adopted pursuant to Section 906 of the
                Sarbanes-Oxley Act of 2002
            
            Filed
                herewith as Exhibit 32.1.


(b)
              Reports
                  on Form 8-K during the year
                  of 2007:




(i)
              Form
                  8-K/A filed on January 4, 2007 disclosing the changes in the Company’s
                  independent certified public accountants;
                  and
 
 (ii)
              Form
                  8-K filed on January 26, 2007 disclosing the Company issued a press
                  release announcing that its common stock has been approved for
                  listing on
                  the NASDAQ Stock Market; and
  (iii)
              Form
                  8-K filed on February 28, 2007 disclosing the Company’s entry into an
                  employment agreement with Ms. Joann Hu pursuant to which she was
                  appointed
                  senior financial officer of the Company;
                  and
  (iv)
              Form
                  8-K filed on March 20, 2007 disclosing the Company’s termination of a
                  certain Voting Agreement dated August 30, 2006, by and among Citadel,
                  Harbin Electric, Inc. and Mr. Tianfu Yang and resignation of Oliver
                  Weisberg as a director of the Company
                  and;
  (v)
              Form
                  8-K filed on April 13, 2007 disclosing the Company’s entry into a Letter
                  Agreement with Shelton Technology, LLC (“Shelton”), Shaotang Chen and
                  Xiaogang Luo whereby the Company and Shelton agreed to work together
                  through the Company’s newly formed, indirect wholly-owned subsidiary,
                  Advanced Automation Group, LLC to design, develop and manufacture
                  custom
                  industrial automation controllers.
  (vi)
              Form
                  8-K filed on October 23, 2007 disclosing the Company’s entry intoan
                  Equity Registration Rights AgreementwithAbax Lotus Ltd., a Cayman Islands limited company (the “Abax Lotus”), Hero
                  Wave Investments Limited, a British Virgin Islands company (“Hero Wave”)
                  and Tianfu Yang, as guarantor, pursuant to which the Company agreed
                  to
                  provide registration rights with respect to (i) an aggregate of
                  700,000
                  shares of common stock of the Company sold by Hero Wave, Broad
                  Globe
                  Investments Limited, a British Virgin Islands limited company,
                  Victory
                  Lake Investments Limited, a British Virgin Islands limited company,
                  and
                  Sea Giant Investments Limited, a British Virgin Islands limited
                  company,
                  to Abax Lotus and (ii) certain additional shares of common stock
                  of the
                  Company which may be subsequently acquired by Abax Lotus on or
                  prior to
                  March 1, 2009.
 
 -
              48 -
 
 **SIGNATURES**




Pursuant
      to the requirements of the Securities Exchange Act of 1934, the registrant
      caused this report to be signed on its behalf by the undersigned, thereunto
      duly
      authorized.




**Harbin
                Electric, Inc.**Date:
                November 14, 2007
            By:
            /s/Tianfu
                YangTianfu
                YangChief
                Executive Officer, Director and Chairman of the Board
              (Principal
                Executive Officer)




Date:
                November 14, 2007
            By:
            /s/Zedong
                XuZedong
                XuChief
                Financial Officer
              (Principal
                Accounting Officer)




**EXHIBIT
      INDEX**





Exhibits:





**Exhibit
                Number**
            
            **Description**
            
            **Method
                of Filing**3.1
            
            Articles
                of Incorporation of the Company
            
            Filed
                as Exhibit 3.1 to the registration statement on Form SB-2 filed with
                the
                Commission on October 10, 2003 and incorporated herein by
                reference.3.2
            
            Amended
                and Restated Bylaws of the Company
            
            Filed
                as Exhibit 10.1 to the current report on Form 8-K filed with the
                Commission on July 6, 2005 and incorporated herein by
                reference.3.3
            
            Amendment
                to the Bylaws of the Company
            
            Filed
                as Exhibit 4.1 to the current report on Form 8-K filed with the
                Commission on December 20, 2006 and incorporated herein by
                reference.10.1
            
            Registration
                Rights Agreement dated as of August 31, 2005
            
            Filed
                as Exhibit 10.1 to the registration statement on Form SB-2 filed
                with the
                Commission on April 27, 2006 and incorporated herein by
                reference.10.2
            
            Common
                Stock Purchase Agreement dated as of August 31, 2005
            
            Filed
                as Exhibit 10.2 to the registration statement on Form SB-2 filed
                with the
                Commission on April 27, 2006 and incorporated herein by
                reference.





-
          49 -




10.3
              
              Option
                  Agreement dated as of August 31, 2005
              
              Filed
                  as Exhibit 10.3 to the registration statement on Form SB-2 filed
                  with the
                  Commission on April 27, 2006 and incorporated herein by
                  reference.10.4
              
              Employment
                  Agreement, dated October 12, 2005, between the Company and Mr.
                  Barry
                  Raeburn
              
              Filed
                  as Exhibit 10.1 to the current report on Form 8-K filed with the
                  Commission on October 17, 2005 and incorporated herein by
                  reference.10.5
              
              Term
                  Sheet dated August 2, 2006
              
              Filed
                  as Exhibit 10.5 to the current report on Form 8-K filed with the
                  Commission on August 2, 2006 and incorporated herein by
                  reference.10.6
              
              Agreement
                  on Cooperation between Harbin Tech Full Electric Co., Ltd. and
                  Institute
                  of Electrical Engineering of the Chinese Academy of
                  Sciences
              
              Filed
                  as Exhibit 10.6 to the current report on Form 8-K filed with the
                  Commission on August 25, 2006 and incorporated herein by
                  reference.10.7
              
              Purchase
                  Agreement among the Company, Advanced Electric Motors, Inc., Citadel
                  Equity Fund Ltd. and Merrill Lynch International, dated August
                  29,
                  2006
              
              Filed
                  as Exhibit 4.1 to the current report on Form 8-K filed with the
                  Commission
                  on September 1, 2006 and incorporated herein by
                  reference.10.8
              
              Indenture
                  among the Company, Advanced Electric Motors, Inc. and The Bank
                  of New
                  York, as trustee, dated August 30, 2006
              
              Filed
                  as Exhibit 4.2 to the current report on Form 8-K filed with the
                  Commission
                  on September 1, 2006 and incorporated herein by
                  reference.10.9(a)
              
              2010
                  Global Note
              
              Filed
                  as Exhibit 4.3(a) to the current report on Form 8-K filed with
                  the
                  Commission on September 1, 2006 and incorporated herein by
                  reference.10.9(b)
              
              2012
                  Global Note
              
              Filed
                  as Exhibit 4.3(b) to the current report on Form 8-K filed with
                  the
                  Commission on September 1, 2006 and incorporated herein by
                  reference.10.10
              
              Registration
                  Rights Agreement between the Company and the Investors, dated August
                  30,
                  2006
              
              Filed
                  as Exhibit 4.4 to the current report on Form 8-K filed with the
                  Commission
                  on September 1, 2006 and incorporated herein by
                  reference.10.11
              
              Share
                  Pledge Agreement between the Company and The Bank of New York,
                  as
                  collateral agent, dated August 30, 2006
              
              Filed
                  as Exhibit 4.5 to the current report on Form 8-K filed with the
                  Commission
                  on September 1, 2006 and incorporated herein by
                  reference.10.12
              
              Warrant
                  Agreement between the Company and The Bank of New York, as warrant
                  agent,
                  dated August 30, 2006
              
              Filed
                  as Exhibit 4.6 to the current report on Form 8-K filed with the
                  Commission
                  on September 1, 2006 and incorporated herein by
                  reference.10.13(a)
              
              Global
                  First Tranche 2012 Warrants
              
              Filed
                  as Exhibit 4.7(a) to the current report on Form 8-K filed with
                  the
                  Commission on September 1, 2006 and incorporated herein by
                  reference.


-
          50 -




10.13(b)
              
              Global
                  Second Tranche 2012 Warrants
              
              Filed
                  as Exhibit 4.7(b) to the current report on Form 8-K filed with
                  the
                  Commission on September 1, 2006 and incorporated herein by
                  reference.10.13(c)
              
              Global
                  2009 Warrants
              
              Filed
                  as Exhibit 4.7(c) to the current report on Form 8-K filed with
                  the
                  Commission on September 1, 2006 and incorporated herein by
                  reference.10.14
              
              Voting
                  Agreement among the Company, Tianfu Yang and Citadel Equity Fund
                  Ltd.,
                  dated August 30, 2006
              
              Filed
                  as Exhibit 4.8 to the current report on Form 8-K filed with the
                  Commission
                  on September 1, 2001 and incorporated herein by
                  reference.10.15
              
              Noncompetition
                  Covenant and Agreement among Citadel Equity Fund Ltd., Merrill
                  Lynch
                  International and Tianfu Yang, dated August 30, 2006
              
              Filed
                  as Exhibit 10.15 to the Registration Statement on SB-2 filed with
                  the
                  Commission on October 4, 2006 and incorporated herein by
                  reference.10.16
              
              Agreement
                  between Harbin Tech Full Electric Co., Ltd. and Shanghai Lingang
                  Investment and Development Company Limited, dated September 8,
                  2006
              
              Filed
                  as Exhibit 10.15 to the Registration Statement on SB-2 filed with
                  the
                  Commission on October 4, 2006 and incorporated herein by
                  reference.10.17
              
              Letter
                  Agreement dated April 9, 2007 by and among Harbin Electric, Inc,
                  Shelton
                  Technology LLC, Shaotang Chen and Xioagang Luo
              
              Filed
                  as Exhibit 10.1 to the current report on Form 8-K filed with the
                  Commission on April 13, 2007 and incorporated herein by
                  reference.10.18
              
              License
                  Agreement dated as of April 9, 2007 by and among Advanced Automation
                  Group. LLC, Shelton Technology, LLC, Shaotang Chen and Xiaogang
                  Luo
              
              Filed
                  as Exhibit 10.2 to the current report on Form 8-K filed with the
                  Commission on April 13, 2007 and incorporated herein by
                  reference.10.19
              
              Employment
                  Agreement dated April 9, 2007 by and between Advanced Automation
                  Group,
                  LLC and Shaotang Chen
              
              Filed
                  as Exhibit 10.3 to the current report on Form 8-K filed with the
                  Commission on April 13, 2007 and incorporated herein by
                  reference.10.20
              
              Employment
                  Agreement dated April 9, 2007 by and between Advanced Automation
                  Group,
                  LLC and Xiaogang Luo.
              
              Filed
                  as Exhibit 10.4 to the current report on Form 8-K filed with the
                  Commission on April 13, 2007 and incorporated herein by
                  reference.14.1
              
              Code
                  of Ethics and Business Conduct
              
              Previously
                  filed.21.1
              
              List
                  of subsidiaries
              
              Filed
                  as Exhibit 21.1 to the quarterly report on Form 10-QSB filed with
                  the
                  Commission on May 15, 2006 and incorporated herein by
                  reference.


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31.1
              
              Certification
                  by the Chief Executive Officer pursuant to Rule 13a-14(a) or
                  15d-14(a)
              
              Filed
                  herewith as Exhibit 31.1.31.2
              
              Certification
                  by the Chief Financial Officer pursuant to Rule 13a-14(a) or
                  15d-14(a)
              
              Filed
                  herewith as Exhibit 31.2.32.1
              
              Certification
                  of the Chief Executive Officer and the Chief Financial Officer
                  pursuant 18
                  U.S.C. Section 1350, as adopted pursuant to Section 906 of the
                  Sarbanes-Oxley Act of 2002
              
              Filed
                  herewith as Exhibit 32.1.





(b)
            Reports
                on Form 8-K during the year
                of 2007:  (i)
                Form
                    8-K/A filed on January 4, 2007 disclosing the changes in the
                    Company’s
                    independent certified public accountants;
                    and
 
 (ii)
                Form
                    8-K filed on January 26, 2007 disclosing the Company issued a
                    press
                    release announcing that its common stock has been approved for
                    listing on
                    the NASDAQ Stock Market; and
  (iii)
                Form
                    8-K filed on February 28, 2007 disclosing the Company’s entry into an
                    employment agreement with Ms. Joann Hu pursuant to which she
                    was appointed
                    senior financial officer of the Company;
                    and
  (iv)
                Form
                    8-K filed on March 20, 2007 disclosing the Company’s termination of a
                    certain Voting Agreement dated August 30, 2006, by and among
                    Citadel,
                    Harbin Electric, Inc. and Mr. Tianfu Yang and resignation of
                    Oliver
                    Weisberg as a director of the Company
                    and;
  (v)
                Form
                    8-K filed on April 13, 2007 disclosing the Company’s entry into a Letter
                    Agreement with Shelton Technology, LLC (“Shelton”), Shaotang Chen and
                    Xiaogang Luo whereby the Company and Shelton agreed to work together
                    through the Company’s newly formed, indirect wholly-owned subsidiary,
                    Advanced Automation Group, LLC to design, develop and manufacture
                    custom
                    industrial automation controllers.
  (vi)
                Form
                    8-K filed on October 23, 2007 disclosing the Company’s entry intoan
                    Equity Registration Rights AgreementwithAbax Lotus Ltd., a Cayman Islands limited company (the “Abax Lotus”), Hero
                    Wave Investments Limited, a British Virgin Islands company (“Hero Wave”)
                    and Tianfu Yang, as guarantor, pursuant to which the Company
                    agreed to
                    provide registration rights with respect to (i) an aggregate
                    of 700,000
                    shares of common stock of the Company sold by Hero Wave, Broad
                    Globe
                    Investments Limited, a British Virgin Islands limited company,
                    Victory
                    Lake Investments Limited, a British Virgin Islands limited company,
                    and
                    Sea Giant Investments Limited, a British Virgin Islands limited
                    company,
                    to Abax Lotus and (ii) certain additional shares of common stock
                    of the
                    Company which may be subsequently acquired by Abax Lotus on or
                    prior to
                    March 1, 2009.




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